March 28, 2005

Document of the World BankR

eport No. 31783- IN

IndiaEconom

ic Grow

th and Poverty Alleviation in Tam

il Nadu

Report No. 31783-IN

IndiaEconomic Growth and Poverty Alleviationin Tamil NaduNotes on Selected Policy Issues

Poverty Reduction and Economic ManagementSouth Asia

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TABLE OF CONTENTS

OVERVIEW ................................................................................................................................................................ I EXECUTIVE SUMMARY .................................................................................................... . .............................. ... I11 I. DEVELOPMENT OUTCOMES AND CHALLENGES ............................ ...... ................... . .......... ..... ........... 1

DEVELOPMENT OUTCOMES ......................................................................................................................... 1 DEVELOPMENT CHALLENGES ..................................................................................................................... 4 REFORM AGENDA . . . . . ........... 8

ACHIEVING FISCAL CORRECTION AND STABILIZATION .............................................................. 14 11. TAMIL NADU’S FISCAL REF0 ................................................................................................................. 14 INITIAL OUTCOME OF FISCAL REFORM ....... MEDIUM-TERM ADJUSTMENT PATH ....... ......

. . . . . . .

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . .. . . .. . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . .27 FISCAL SUSTAINABILITY AND R I S K S ................................

111. IMPROVING INVESTMENT CLIMATE FOR MANUFACTURING AND SERVICES ................ ...... 32 REMOVING REGULATORY BURDENS ......................................................................................................... 32 RESOLVING INFRASTRUCTURE BOTTLENECKS ..................... INSTITUTIONALIZING PUBLIC AND PRIVATE SECTOR DIAL0

IV. REINVIGORATING AGRICULTURE GROWTH .................................................................................... 41 .............................................. 41 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .42

SALIENT FEATURES OF AGRICULTU RE............. EFFICIENT WATER RESOURCE MANAGEMENT CHALLENGES OF AGRICULTURE DIVERSIFICATION ....................... ............................. ~ ........

V. IMPROVING PUBLIC ADMINISTRATION AND ENHANCING SERVICE DELIVERY .................. 48 RATIONALIZING THE ROLE OF GOVERNMENT ......................................................................................... 48 STREAMLINING DECISION MAKING . .. . . . . . . . . . . . . . . . . . . . 49 IMPROVING THE STABILITY OF STAFF TENURE ......................................................................... 49 IMPROVING CRITICAL SERVICES WITH A LARGE PUBLIC INTERFACE .................................................... 50 PROCUREMENT REFORM .............................................. 50 RIGHT TO INFORMATION ..................................................... 51 ENFORCING ANTI-CORRUPTION ............................................................................................................... 51

VI. STRENGTHENING POVERTY MONITORING AND EVALUATION .................................................. 53

VII. REFORM CHALLENGES AND R I S K S ..................................................................................................... .55

ANNEXES ANNEX I. A FUNCTIONAL REORGANIZATION SCHEME FOR THE COMMERCIAL TAX DEPARTMENT 61 ANNEX 2. BUDGET AND FINANCIAL MANAGEMENT REFORMS 64 ANNEX 3. REFORMS TO IMPROVE THE INVESTMENT CLIMATE 69

FISCAL DATA ANNEX 72

REFERENCES 77

Economic Growth and Poverty Alleviation in Tamil Nadu Notes on Selected Policy Issues

Preface

This volume presents a synthesis o f five policy notes prepared by the Wor ld Bank staff in collaboration with the Government of Tamil Nadu to support i t s reform program between 2002 and 2004. The five notes span fiscal reform and sustainability, improving investment climate, agnculture development, governance challenges, and poverty profile. An overview o f the main messages o f the five notes i s also presented. The report reflects the status o f policy dialogue up to March 2004 with a few selected updates. Some caveats are in order.

ACKNOWLEDGEMENT

The notes were prepared by a team led by Lili Liu and Mohan Nagarajan, under the overall guidance o f Sadiq Ahmed and Michael Carter, and with advice f rom I jaz Nabi and Stephen Howes. The peer reviewer i s Shahid Yusuf. Major contributions to the notes are listed below. Ahmad Ahsan provided valuable comments on the report.

Fiscal Reform and Sustainability: Lili Liu, Mohan Nagarajan (co-task managers), Michael Engelschalk and Tuan Minh L e on tax policy and administration, Anand Rajaram on expenditure reform, Mohan Gopalakrishnan and Peter Dean on financial management and accountability, Elena Ianchovichina o n fiscal sustainability, Yee Mun Sin on pension reform, Rajesh Sinha and Rohit Mi t ta l on power, and Smita Kuriakose on fiscal data.

Improving Investment Climate: Lili Liu, Simon C. Be l l and Abha Joshi-Ghani (task mangers), Taye Alemu Mengistae on investment climate survey and analysis, Andrew Singer on regulatory constraints, Nagavalli Annamalai o n labor market reform, Michael Engelschalk and Tuan Minh L e o n tax pol icy and administration, David Dowal l o n urban land market, Rajesh Sinha and Rohit Mi t ta l on power, Amab Bandyopadhyay on roads, Abha Joshi-Ghani o n water, and Ted Liang on ports.

Agriculture Development: Paul A. Dorosh and Mona Sur.

Governance Challenges: Vikram K. Chand.

Poverty ProJile: Tara Vishwanath (coordinator), Peter F. Lanjouw (poverty profile), and Ra j i Jayaraman (village studies).

Shahnaz Sultana Ahmed, Jyoti Sriram, Thelma Rutledge, and Oxana Bricha provided document preparation.

The pol icy notes were developed in consultation with the Government o f Tamil Nadu. The counterpart was led by Mr. N. Narayanan, Finance Secretary and Development Commissioner. Officials in the Finance Department, Industry Department, Agriculture Department, Public Administration Department, Labor Department, Tamil Nadu Electricity Board and numerous other government departments, agencies and statutory boards provided unstinted help during the preparation o f the report. Special thanks are particularly due to Mr. L. Krishnan, Special Secretary, Finance Department, Mr. Ashish Vachhani, Deputy Secretary, Finance Department and Mr. Brajendra Navnit, Deputy Secretary (Budget) for their

unstinted generosity with al l manner o f data and information. As always any shortcomings l ie squarely with the authors.

W e are also grateful to the large number o f enthusiastic participants, too numerous to name, who participated in the workshop in Chennai held in October 2004. Their comments were al l welcome. We are especially thankful to Professor Rajah J. Chelliah, Chairman, Madras School o f Economics, Dr. V. K. Natraj, formerly, Director o f the Madras Institute o f Development Studies, Mr. Subhash C. Garg, Joint Secretary, Department o f Expenditure, Ministry o f Finance, Government o f India and Mr. B. Santhanam, Saint Gobain Glass India Ltd. for their support and perceptive comments.

Economic Growth and Poverty Alleviation in Tamil Nadu Notes on Selected Policy Issues

OVERVIEW

1. Tamil Nadu has emerged as the fifth largest economy in India (its population o f 62 mi l l ion i s the seventh largest). I t s GSDP i s about US$38 bi l l ion at official exchange rate or over US$lOO bi l l ion based on purchasing power parity. Tamil Nadu has achieved solid development outcomes, with economic growth higher, and poverty reduction faster, than the India average in the 1990s. I t i s one o f India’s most urbanized states, with the third highest Human Development Index (HDI) among 29 states. I t also has an educated, hard working and disciplined workforce, and a capable c iv i l service.

2. But Tamil Nadu has an unfinished development agenda. The state has a relatively high poverty incidence o f about 20% and intra-state disparities in progress toward the attainment o f the Mi l lennium Development Goals (MDGs). A fiscal crisis that peaked in 1999/00-2000/01 and slowdown in economic growth since the late 1990s threaten the prospects for sustained poverty reduction. Repeated droughts and growing water shortages heighten the importance o f structural transformation that would reduce the vulnerability o f the economy to periodic droughts through fluctuation in agriculture and i t s spillover to other sectors, and make available scarce water resources to higher value-addition industrial and service sectors. The faster growth o f these two sectors would help absorb agriculture’s surplus labor and reduce high unemployment rate o f the state.

3. Such structural transformation must be underpinned by fiscal adjustment to put public finances on a sustainable path, while at the same time reorienting public spending from consumption to growth- enhancing and poverty-reducing spending in critical infrastructure and social services. Power sector reforms to reduce the sector’s claim on fiscal resources and improve power supply i s a high priority. Equally important are enabling investment climate improvement to promote private investment in manufacturing and services, policies and institutional reforms to encourage agriculture diversification to high value and less water-intensive crops, and improving governance for service delivery.

4. Spurred by the mounting fiscal crisis and slowing growth, the Govemment o f Tamil Nadu (GoTN) started implementing wide-ranging fiscal and structural reforms from late 200 1 to 2003104. Though a late comer, Tamil Nadu’s fiscal reform proceeded at a rapid pace that stemmed the fiscal decline. Several reforms were bold and path breaking both in the context o f the past history o f the state, and in the national context. However, fiscal policy reversals by the G o T N in areas such as electricity tariff, the public distribution system and user charges - in the aftermath o f electoral losses in the April- M a y 2004 national elections - have the potential o f increasing the revenue (current) and fiscal deficit and jeopardize the gains made thus far, threatening fiscal consolidation and the credibility o f the Med ium Term Fiscal Program (MTFP). Tamil Nadu has l itt le choice but to return to the path o f fiscal consolidation if it i s to meet i t s development goals.’

5. Tamil Nadu was struck by a massive tsunami on December 26, 2004 leading to tragic loss o f 8,010 lives and loss of l ivelihood o f 400,000 families. 130,000 families were displaced. The Tamil Nadu government has estimated the financial requirements for re l ief and rehabilitation to the victims o f this massive human tragedy and affected infrastructure at Rs. 4,800 crore. Rehabilitation and restoration o f l ivelihood i s expected to be spread over three years. T h i s report was wri t ten before the tsunami struck Tamil Nadu. An assessment o f the economic and fiscal impact o f the tsunami has therefore not been

’ Tami l Nadu’s tenth p lan (2002-2007) envisages a real economic growth rate o f 8%. The Plan’s goal i s to make Tami l Nadu the best state in the country and provide opportunities for a healthy and productive l i f e for all.

factored into this report. Preliminary estimates o f the fiscal impact on the state’s finances o f the expenditure on tsunami r e l i e f and rehabilitation for 2004105 are placed at 0.2 percent o f GSDP and over the next three years the impact i s estimated to be 0.7 percent o f GSDP each year. However, the actual fiscal impact o n Tamil Nadu will depend on the nature o f the relief assistance provided by the Government o f India to the G o T N and h o w much o f that wi l l be through the state’s budget andor through banks and cooperative institutions. T o the extent that a grant element will dominate central government assistance to tsunami affected states to meet the cost o f rehabilitation the fiscal impact o n the state will be minimized. Some o f the assistance will be passed through to the state budget, such as central govemment subsidy to fishermen to obtain loans f rom commercial banks to repair and buy boats. For instance out o f Rs. 2,347 crore assistance announced recently by the central government for purchase o f fishing vessels and nets grants o f only Rs. 441 crore would be routed through the Tamil Nadu government whereas the rest i s to be provided as soft loans by commercial banks.

6. The other event that will have a great bearing on state governments’ finances over the next five years beginning 2005/06 i s the Twelfth Finance Commission’s (TFC) awards for the period 2005/06 to 2009/10. The TFC has fixed Tamil Nadu’s share in the total divisible pool o f central taxes at 5.305% as opposed to the prevailing 5.385%, a marginal decrease. But states’ share in the centre’s total divisible tax pool has been increased from 29.5% to 30.5%. Tamil Nadu’s effective share i s therefore unaltered at 1.6% o f central taxes. The total devolution o f central taxes to Tamil Nadu over the f ive year period i s estimated by the TFC at Rs. 32,553 crore. The TFC has done away with normal central loan assistance for state plans in favor o f market borrowings. Tamil Nadu i s not affected by this change. The TFC also recommended debt r e l i e f to the states in the form o f restructuring o f all central loans with state governments’ as o f March 31, 2004 outstanding as o f March 31St, 2005. The loans wil l be consolidated and rescheduled at 7.5% interest rate repayable over twenty years. This has been made conditional o n states’ enacting Fiscal Responsibility Legislation which Tamil Nadu govemment already has and i s therefore straightway eligible for debt restructuring. As a result, Rs. 6,872 crore o f outstanding central loans on Tamil Nadu government’s books will be restructured. The TFC has also recommended debt write-off l inked to reduction in the revenue deficit o f the state government. Under the scheme, a certain proportion o f repayment o f rescheduled debt will be written o f f by Government o f India over the period 2005/06 to 2009/10. The quantum o f write-off i s linked to the absolute amount o f reduction in the revenue deficit each year with the ultimate objective o f eliminating the revenue deficit by 2008/09. Tami l Nadu can benefit to the extent o f Rs. 1,718 crore in debt write-off under the scheme. Tami l Nadu also gets Rs. 1,826 crore in special purpose grants over the TFC award period. The TFC’s recommendations and a revised Medium Term Fiscal Policy o f the Tamil Nadu government incorporating the TFC award became available after this report was prepared. This report has been updated with information f rom these two documents to the extent possible.

7. T o provide context, this report begins by reviewing development outcomes and challenges, including the Millennium Development Goals, in Tamil Nadu (Section I). Section I1 focuses o n fiscal correction and sustainability. Section I11 focuses o n improving investment climate for promoting private sector development in manufacturing and services. Section I V i s devoted to reinvigorating agriculture growth. Section V addresses challenges o f strengthening public administration and improving service delivery. Section V I discusses the strengthening o f poverty monitoring and evaluation. Section VI1 concludes with a summary o f reform challenges and risks.

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EXECUTIVE SUMMARY

Tamil Kadu’s Development Achievements and C%ailenges

Successfir1 poverty reduction and development outcomes Tamil Nadu’s performance on poverty reduction was above India’s national average in the 1990s achieving an above-average reduction in poverty in both rural and urban areas. Tamil Nadu’s poverty headcount has reduced from 35.4% in 1993/94 to 2 1.1 % in 1999/2000 according to Planning Commission’s estimates. Notable success has been achieved in human development outcomes too in the state. From being a near-average state with a Human Development Index (HDI) o f 0.343 in 1981, Tamil Nadu has moved to a high-performing state with the third highest HDI o f 0.53 1 in 2001. Tamil Nadu i s on track to meet most o f the Millennium Development Goals (MDGs), with trend performance better than required for such important MDGs as poverty reduction, child malnutrition, school enrollment, and infant mortality.

Tamil Nadu’s success i s the result o f sustained economic growth and an effective human development strategy. The strategy has focused on three main areas: (i) expanding the coverage of social services, (ii) improving the quality o f services provided, and (iii) ensuring wide participation o f the poor and other marginalized groups.

Notwithstanding positive development outcomes, Tamil Nadu faces many development challenges. Sti l l a low-income state, Tamil Nadu has a relatively high poverty incidence, and gender, caste, and intra-state disparities in key poverty and social indicators. High drop-out and l o w completion rates continue to reduce the effectiveness o f Tamil Nadu’s secondary education program. The crude birth rate has been hovering around 19-20, neo-natal mortality has been stagnating, and female infant mortality rate remains high. There are significant rural-urban differentials and inter-district variations. The state also faces a high rate o f malnutrition in children, and confronts a high prevalence o f HIV/AIDS. Tuberculosis i s reemerging in association with H IV /A IDS and non-communicable diseases are on the rise.

Growth has slowed down The liberalization in the 1990s accelerated economic growth in Tamil Nadu. However, in recent years growth has slowed, f rom an annual average o f 6.6% f rom 1990/91 to 1998/99 to an annual average o f about 3.7% from 199.9/00 to 2002/03. M u c h o f the recent slowdown i s attributed to the impact o f the droughts on agriculture and their spillover to other sectors. Three annual droughts, l ed to an annual average o f -3.9% growth during 1999/00-2002/03 compared with an annual average o f 4.5% in the previous nine years. Although droughts are exogenous shocks, there are structural impediments, overcoming which could put economic growth on a higher trajectory path o f 8% targeted by the G o T N to accelerate the pace o f poverty reduction. Tamil Nadu’s agriculture faces challenges o f growing water scarcity, land-degradation, decline in farm sizes, and rising cost o f agncultural labor.

Although, Tamil Nadu has been one o f the most favored foreign and domestic investment destinations in India accounting for 15% o f all-India merchandise exports and 17% o f all-India IT exports, the investment climate faces several constraints. Rigid labor regulations, a complex and cascading indirect tax system, protracted exit and bankruptcy procedures, and infrastructure deficiencies are among the key constraints to better manufacturing performance in India and Tamil Nadu i s not an exception. The Wor ld Bank’s 2003 investment climate survey o f the manufacturing sector in Tami l Nadu reaffirms this assessment. Higher manufacturing growth, together with the growth o f the service sector, i s critical to absorbing surplus agriculture labor and reducing rural poverty.

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Fiscal Reforms

Fiscal crisis tlireatenedprospects of sustainedpoverty reduction intervention b-v the state The fiscal crisis beginning in 1998/99 and slowdown in economic growth since the late 1990s not only seriously threaten the prospect for sustained poverty reduction in the future but also endanger the gains already made. The most immediate challenge that faced Tamil Nadu in 2001/02 was to reverse the rapid fiscal decline and create fiscal space for development spending. With salaries and pension o f government employees (2% o f the state’s population)-accounting for government’s entire own revenue during the crisis there was l i t t le fiscal space left for essential infrastructure and social spending.

State Government lairnched ambitious reforms targeting fiscal correction and restructuring public expenditure Beginning f rom 2001, the government embarked on ambitious reforms over the next two years touching a number o f areas in both revenue and expenditure. The government proceeded to do so at a rapid pace to catch up with other reforming states such as Andhra Pradesh and Kamataka. Some o f the reforms were bold and path breaking both in the context o f the past history o f the state, such as in the Public Distribution System (PDS) and agriculture power tariff, and in the national context such as pension reform. The reforms were undertaken, notwithstanding a diff icult economic environment posed by successive droughts and l o w economic growth. Significant gains were made over the next two years and aggressive fiscal reform targets were set for the future. By attempting expenditure reallocation the program sought to improve growth and human development achievement.

Critical elements o f the fiscal reform program included: the development o f a multi-year framework for fiscal adjustment through a Medium Term Fiscal Policy Statement (MTFP); improving legislative oversight and fiscal transparency; restructuring high-cost public debt and management o f guarantees; improving the efficiency o f the tax administration; rationalizing user charges; introducing a targeted PDS, introducing apcu l tu ra l power tariff; reforming state-owned manufacturing enterprises and ailing cooperatives; and strengthening public expenditure management and financial accountability to increase the efficiency o f public spending.

The impact o f the fiscal adjustment program has been impressive. W h i l e the revenue (current) deficit declined f rom 2.1% o f Gross State Domestic Product (GSDP) in 2000/01 to 0.9% o f GSDP in 2003/04 and 2004/05(RE), the fiscal deficit declined from 4% o f GSDP in 2000/01 to 2.4% o f GSDP in 2003/04; but increased to 2.9% in 2004/05(RE). The state also achieved a primary surplus o f 0.3% o f GSDP in 2003/04 as compared to a deficit o f -2.5% o f GSDP in 1999/00. A key objective o f fiscal adjustment was cleaning up o f accumulated arrears f rom prior years. A large amount o f arrears, Rs. 3,062 crore equaling to 2% o f GSDP, was cleared in 2002/03, including the securitization o f Rs. 1,962 crore o f dues to central electricity utilities by the Tamil Nadu Electricity Board. The consolidated fiscal deficit (which consolidates the non-power budget fiscal deficit with the Tamil Nadu Electricity Board’s financing requirements) was reduced from a peak o f 6.7% o f GSDP in 1999/00 to 4.8% o f GSDP in 2002/03. The close to two percentage point reduction f rom 1999/00 to 2002/03 was largely attributed to an increase in the ratio o f the state’s own tax revenue to GSDP (from 8.6% in 1999/00 to 9.3% in 2002/03), and a reduction in the ratio o f salaries to GSDP (from 6.5% in 1999/00 to 5.2% in 2002103). The consolidated fiscal deficit decreased further to about 3.8% o f GSDP in 2003/04.

The composition o f expenditure has shown improvement with higher allocations for non- wage Operations and maintenance expenditure, particularly in 2003/04 and 2004/05(RE). The share o f capital outlay, net lending, non wage operations and maintenance expenditure showed sharp recovery in 2003/04 and 2004/05(RE) after declining over the earlier two years.

Based o n the fiscal turnout in 2004/05(RE) and takmg into account the Twelfth Finance Commission’s recommendations, the Government o f Tamil Nadu has tabled a revised M T F P along with the 2005/06

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budget. The M T F P revised along conservative lines seeks to generate a revenue surplus by 2008109 and bring the fiscal deficit to below 3% o f GSDP by 2005/06. The MTFP targets are achievable. Getting the full benefit o f the Finance Commission’s recommendation on debt relief and write-off i s conditional on the state meeting these revised targets.

The Government o f Tamil Nadu has initiated reforms o f the systems and processes o f budget formulation and execution. However, reforms are needed to achieve the Government’s development objectives and to adapt the institutional arrangements to support fiscal strategy. The key challenge i s to ensure that a comprehensive resource framework and a medium-term perspective effectively guide the three objectives o f budget management: aggregate fiscal discipline in line with the medium-term fiscal program, strategic policy decisions by the Government within the constraints o f the fiscal program, and efficient use o f public expenditure in government operations. The Tamil Nadu Fiscal Responsibility Ac t (FRA), already passed by the government lays the foundation for aggregate fiscal discipline by emphasizing transparency and disclosure o f the medium-term fiscal program with each budget. But attention will be required to comply with FRA provisions.

Tamil Nadu needs to substantially strengthen i t s upstream capacity for policy formulation. The establishment o f a Policy Review Committee, to be chaired by the Development Commissioner, could provide leadership and focus to this key capacity-enhancing reform. The Policy Review Committee can re ly o n a network of public and private institutions to undertake public policy research and analysis.

An early submission o f the draft budget to the legislature can help bring budget approval closer to the start o f the fiscal year, facilitating budget execution. A review o f budget execution processes can help identify and address current weaknesses. Together with improvements in internal control systems, the Government should explore an increase the scope for virement within departmental budgets. The Government should also plan to constitute a standing Expenditure Review Committee to undertake rol l ing annual reviews o f departments to identify unproductive programs and to rationalize and improve efficiency o f existing programs.

The framework for public financial accountability in Tamil Nadu i s generally sound. Nevertheless, several areas need strengthening. The need for reform i s particularly evident in the area o f budget execution procedures, including the weaknesses in internal controls and the need to eliminate or reduce reliance o n Personal Deposit Accounts in the Public Accounts. The Government also needs to develop measures to address key internal control issues such as reconciliation o f accounts, reconciliation o f loans and advances, timely submission o f utilization certificates, and incentives for compliance.

Policy reversals after national elections of 2004 impede accelerated progress in fiscal restructuring Fol lowing the national elections in Apri l -May 2004, in the state, key policy reforms were rolled back. A series o f quick reversal o f significant reform measures was announced (power, PDS and reintroduction o f free bus passes for students and withdrawal o f other minor user charges). This has posed increased expenditure besides making it more diff icult in the future to return to the pol icy reform path. Extension o f free power to al l agriculturists and slashing power tar i f f to domestic consumers to pre-reform levels o f 2001 i s expected to cost Rs. 920 crore in 2004/05, withdrawal o f PDS targeting wil l raise food subsidy by about Rs. 130 crore in 2004/05 and restoration o f student bus passes & concession fare would cost Rs. 125 crore in 2004105. Additional expenditure o n account o f these proposals in 2004/05(RE) i s about Rs. 1,650 crore. The impact o f these i s seen in the 2004/05(RE) wherein despite higher revenue outturn and large savings in salary and pension expenditure (as compared to the budget), the fiscal deficit increased to 2.9% o f GSDP as compared to 2.4% in 2003104.

If the fiscal reform and MTFP are broadly o n track, Tamil Nadu’s debt stock i s expected to stabilize around 31% o f GSDP (from 28% in 2003/04), a level below that in many other Indian states. However,

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due to fiscal burden o f recent policy reversals, the debt to GSDP ratio may increase to 32% o f GSDP by 2008/09.

Improv ing the lnvestmcnt Cl imate

Complementary focus on improving the investment climate required for accelerating growth Fiscal reform must be complemented with a strong program to improve the investment climate for accelerating economic growth and poverty reduction. Findings f rom the investment climate surveys in Tamil Nadu suggest that cumbersome and excessive regulation and infrastructure bottlenecks are major or serious constraints to growth. Recognizing the role o f the private sector as an engine o f economic growth, the Government o f Tamil Nadu has put emphasis on streamlining complex government. regulations over private investment and production, and on strong partnership with the private sector for sustainable infrastructure financing and development. A number o f infrastructure projects executed in the Public Private Partnership (PPP) format bear testimony to government’s commitment.

The reform agenda before the government deals with not only regulatory policies and practices concerning al l factor markets (labor, land, and capital), but also regulation o f entry/exit for enterprises and tax policy and administration. There are 23 Union Acts and seven State Acts and Rules which are enforced by the Labor Department in Tamil Nadu. For each o f these subjects there are different enactments by the center as well as implementing ru les by the state. Many regulations are excessive and outdated (e.g., n o overlapping o f shifts, capping o f overtime, official permission required for working on Sunday or holidays, specified number o f food cafeterias, and over 60 types o f minimum wages). Labor regulations are largely within the purview o f the central government. Nonetheless, within the federal framework, Tamil Nadu can explore ways to rationalize and consolidate implementing ru les concerning the legal framework governing labor and statutory compliance requirements to create elbow room for contractual labor relationship and for easing threshold for retrenchment.

Urban land market suffers from systemic weaknesses Tamil Nadu’s urban land market suffers f rom systemic weaknesses. Master plan designations in the absence o f complementary incentives and measures make the supply o f land for development inefficient. Urban land issues are within the purview o f the state government. It i s important to rationalize regulations o n urban land zoning and development controls, and project approval and land acquisition processes, and develop a more effective planning and management system to facilitate infrastructure development.

Tax administration imposes high compliance costs The tax administration imposes high compliance costs by, for example, lack o f self-assessment in the sales taxation for large businesses and o f electronic filing, cumbersome registration procedures, and time- consuming dispute resolution, which al l encourage undesirable frequent contacts between businessmen and tax officials. Some o f these and tax issues will be resolved when VAT i s implemented.

Streamlining Business Entry Tamil Nadu has made progress in simplifying regulations over business entry. The sequential and protracted approval process involv ing multiple government departmentdagencies has been replaced by a streamlined and coordinated one for large investment projects. The streamlined process for large investment projects needs to be extended to al l small and medium-sized and small projects.

Infrastructure a constraint to improving competitiveness Power has become a major infrastructure constraint despite the relative efficiency o f the state power utility and having the second largest power market in India. High power tar i f f t o industries and poor quantity and quality o f power supply reduce the competitiveness o f Tami l Nadu’s industries. The financial stress o f the TNEB, arising largely f rom cross subsidy to agnculture (and n o w the domestic

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consumer segment also), has increasingly constrained i t s investment ability to improve the quality o f power supply. L i k e many other states, Tamil Nadu will need to find a political solution to the metering o f agriculture pump sets and reduction o f cross-subsidy to improve the competitiveness o f industry and services.

A clear regulatory framework for support o f public private partnerships in infrastructure needs to be put in place which would define the role o f the government and the private sector, lay out the risk sharing principles and also regulate the tar i f f regime for private roads. An important priority i s to press forward with fiscal reform to create fiscal space for investment in the infrastructure sector.

Priority Reforms Priority reforms comprise the following areas: labor market flexibility; a more responsive urban land supply system; more efficient tax policy and administration; continuing reform to ease entry and operation; power sector reform; and scaling up PPP for sustainable infrastructure development. Some o f which are not entirely in the state’s purview, but which the state can articulate in i t s dialogue with the central government. The wide scope o f issues i s not surprising and will thus require an institutionalized dialogue between the Government and the private sector for setting priorities and finding solutions.

Agriculture

Traditional sources of agricultural growth face major constraints While agncultural sector growth rates in Tamil Nadu were among the highest in India during the 1980s and early 1990s, deceleration in growth since the mid-1990s i s o f increasing concern to policymakers. During the 1980s agricultural GSDP grew at 3.4 percent, exceeding the all-India agricultural growth o f 2.9 percent. But repeated drought in the nineties meant that the state’s agncultural growth rate was only 2.9 percent a year, compared with 3.2 percent for the nation. Analysis has shown that a one percent increase in rainfall relative to the mean i s associated with a 0.3 percent increase in real agricultural GDP relative to the trend agricultural GDP.

There are three salient features o f Tamil Nadu’s agriculture that set the political economy context for searching a viable strategy for revitalizing agriculture growth: water scarcity; the large share o f rice and sugar cane (both water-intensive crops) in total irrigated land; and the dominance o f small and marginal farmers in overall agriculture production. Faster growth in agriculture i s central to rural development and poverty reduction in Tamil Nadu. Although agriculture accounts for only 14% o f Tami l Nadu’s GSDP and non farm income accounts for about 50% o f rural household income, farm income accounts for about ha l f o f household income for 35 mi l l ion people (56 percent o f the state’s population) who l ive in rural areas.

Traditional sources o f agncultural growth, however, face major constraints including growing water scarcity, increasing land degradation and declining farm sizes, and rising costs o f agricultural labor. The agricultural sector faces increasing competition for water f rom industry and domestic users and intensifying interstate competition for surface water resources. In many parts o f the state, the rate o f extraction o f groundwater has exceeded recharge rates, contributing to falling water tables. Efficient water resource management i s a key priority for not only agriculture but also the entire state economy requiring complex regulatory and institutional changes beyond the medium term.

Crop Diversijkation important for future agricultural growth Given water scarcity, diversification into less-water intensive higher-value products i s the most promising avenue for future agricultural growth. Broader institutional and pol icy reforms are required to efficiently manage scarce water resources, decentralize the agricultural extension system, improve rural infrastructure to facilitate efficient markets, and reorient public expenditure towards growth-enhancing areas such as rural roads, markets and agncultural research.

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Marginal Cost pricing of water arid electricity will rationalize water use Gradual steps towards marginal cost pricing o f water and electricity, (perhaps combined with compensation to farmers in the form o f income transfers or more reliable electricity supply), would help rationalize water use in Tamil Nadu. The agncultural power tar i f f introduced in March 2003 included a flat rate for unmetered connections o f Rs.250 per horsepower a year and Rs.0.20 per kilowatt-hour for metered connections. Along with the reintroduction o f agricultural power tariff, the government announced an income support scheme for smallholders and marginal farmers. Under the income support scheme, the Government o f Tamil Nadu provided smallholders and marginal farmers a transfer o f up to Rs. 1,250 a year. This was a significant step toward creating a more direct and transparent system o f subsidies to farmers and other target groups and ensuring the separation o f commercial operation o f the power utility f rom the need for subsidy. However, these initiatives were rol led back after the national elections in 2004.

Metering o f farmers i s critical to link agricultural tariffs to consumption levels. Metering will also enable power subsidy to be better targeted. If farmers costs and incomes varied according to the amount o f electricity (and water) used with wel l irrigation, farmers would have an incentive to shift some land from water-intensive crops towards less water-intensive crops. Greater attention to marketing infrastructure, strengthening the research and extension system to meet the needs o f diversified agriculture, the development o f tools for farmers to better manage risks, improving irrigation pump set efficiency and putting in place safety net program to cushion against the r i sk o f diversification particularly for small and marginal farmers who rely mainly on agnculture subsistence income may create an environment within which higher power charges would be more palatable for farmers.

Governance and Service Del ivery

The government’s capacity to deliver services needs strengthening The strengthening o f public expenditure management and financial accountability would need to be supported by public administration reform to enhance service delivery. Tamil Nadu has done wel l in delivering key services: A recent survey conducted by the Public Affairs Center reveals that the state has the country’s best public distribution and school education systems, and the second best public drinking water and road transport services after Gujarat. This, o f course, i s not a uni form picture: health services, for example, are ranked fifth.

Tamil Nadu faces several critical challenges that need to be addressed to preserve and extend the gains made so far. T o support fiscal reform and the reform o f the investment climate, service delivery reform would also need to focus on strengthening the effectiveness o f the government by rationalizing i t s role and responsibilities, simplifying decision-malung processes, improving the stability o f staff tenure, and enhancing critical services delivery-which have a large public interface through a combination o f measures such as agency reform, e-governance, and public private partnerships. Further, the reform would need to address the transparency issues regarding government and corruption, through a major overhaul o f the public procurement system, enacting new “Right to Information” legislation, and strengthening the anti-corruption machinery.

Improving Civil Service productivity is key to efflcierit government The c iv i l service in Tamil Nadu has proliferated in the last twenty years: Tami l Nadu today possesses the highest ratio o f c iv i l servants per hundred population in India o f any major state after Punjab. To rationalize and restructure the c iv i l service and improve i t s productivity, the Government constituted a Staff and Expenditure Reforms Commission (SERC) in December 2001 to systemically review and realign the roles and responsibilities o f each o f the 140 departments and identify redundant departments/functions/posts, including areas where the government should exit and le t the private sector take over. The exercise was carried out with the benefit o f extensive consultation within the government, including with staff associations and unions, as wel l as consultation with the public. The SERC reports

v i i i

have identified about 85,000 surplus posts, and 113,000 vacant posts made feasible by hiring freeze. The reduction in the core c iv i l service size (posts) by 2007/08 (from 2002/03) can be achieved by abolishing 85,000 posts using 2002103 as the base year. The abolishing o f the surplus posts will enable a more efficient allocation o f staff across departments within the targeted ceiling.

T o simplify the decision-making process, the SERC also reviewed the functioning o f the Secretariat, focusing on improving efficiency through delegation to heads o f departments, level-jumping, the introduction o f the single-file system, and computerized f i l e monitoring and greater flexibility for redeploying staff. The government has issued orders permitting level jumping o f files.

Responding to the problem o f pre-mature transfers, the Government introduced a system o f formal counseling for transfers in both the Health and Education Departments. The Government has also issued orders regarding norms to be followed in transfers covering the entire c iv i l service. The order specifies transferring authorities, established norms for three- to seven-year tenure, l imited transfers to 20% o f cadre strength and to the season only, and announced the creation o f a public transfer database on the internet to track transfers over time.

Room for improving Service Delivery While Tamil Nadu has done wel l in service delivery in some key areas relative to the rest o f the country, there i s s t i l l room for improvement. A number o f reforms are ongoing; these include improving the Registration Department by introducing a computerized guidance value calculation software package for use in i t s sub-registries, and promoting the development o f luosks in villages to improve rural service delivery and empower rural citizens.

Over the next few years, in addition to policy and institutional reforms ifi critical sectors such as water supply and sanitation, education and health to enhance service delivery, the Government plans to focus on improving 10 critical services with a large public interface, including regional transport services, commercial tax, stamps and registration for property transfers, district administration, and local bodies. I t plans to accomplish this through a combination o f measures such as e-governance, process reengineering, citizens’ charters, and partnerships with the private sector. Revision o f citizen charters for agencies with large public interface must be done on a priority basis (e.g. district hospitals) and surveys used to provide feedback.

Systemic reforms required to improve Transparency Tamil Nadu was the f i rs t Indian state to introduce legislation, in October 1998, to improve transparency in public procurement and to regulate tendering and contracting procedures o f government departments, statutory bodies, public sector enterprises and other local bodies. The pace o f procurement reform has been accelerated, focusing on the implementation o f the Act. The government has completed a three-year comprehensive procurement reform action plan. This will include: setting up a complaint/challenge/appeal mechanism; finalizing and issuing f ive sets o f Standard Bidding Documents; finalizing the revision o f Finance, Accounts, and Public Works codes; improving works procurement procedures; introducing code o f ethics for officials and the business community and tightening enforcement; evaluation o f reservation and exemptions with a v iew to provide a level-playing field; enlarging the scope o f rules to cover consultant selection procedures; and issuing guidelines and directives o n procedural improvements.

In addition to ongoing systemic reforms to prevent corruption (e.g., procurement reform, business deregulation, e-governance, and fiscal transparency), enforcement efforts need strengthening. The Vigilance Commission and i t s investigating agency, the Department o f Vigilance and Anti-Conuption (DVAC) function as government agencies. Neither the Vigilance Commission nor the D V A C possessed a public website to disseminate performance information. The government needs to consider the creation

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o f an independent institutional mechanism to focus on corruption and grievance redressal in service delivery, and greater transparency in the functioning o f D V A C .

Tamil Nadu passed the country’s first Right to Information (RTI) Act in 1997; the Ac t i tself , however, was flawed with numerous exemptions. The law falls below GoI’s standards set in the Freedom o f Information Ac t (2002), as wel l as the standards o f state laws in Delhi, Karnataka, and Maharashtra. The Government i s currently preparing a new draft law that will provide for minimal exceptions, an independent appeals process, penalties for non-compliance, and more automatic disclosure o f information by departments.

Poverty and Human Development

Tlie capacity to monitor the progress of poverty and human development remains critical About 12 mi l l ion people l ive in poverty in Tamil Nadu. Scheduled castes and tribes are highly represented among the poor due in part to their owning less land, and o f lower quality, as wel l as other assets (particularly human capital). Important challenges in the non-income dimensions o f poverty remain to be tackled in health, education, water supply and sanitation and nutrition.

The broad structural reform program thus needs to be supported by protecting the poor and vulnerable through targeted interventions. The Tenth Five-Year Plan provides a detailed description o f the poverty- reduction programs, which are wide ranging, to cover health, education, water supply and sanitation, and food security. These programs include schemes targeted to particular social and demographic groups such as scheduled castes and tribes, women and children. The specific interventions broadly match the spatial and social needs revealed by the poverty diagnostics although there i s scope for improving the design and targeting efficiency. To this end, strengthening poverty monitoring and evaluation for effective targeting i s an important focus area. For example, developing strong institutional capacity for evaluation based learning i s invaluable for improving the targeting in schemes such as the Public Distribution System. Similarly, building institutional capacity for an effective monitoring and feedback mechanism that ensures aligning o f budgets to priority needs in education, health and broader aspects o f service delivery will be important in the coming years.

There appears to be a case for paying special attention to the rural areas in the Coastal Nor th and the South, and possibly to the urban areas in the Coastal North. Scheduled Castes and Scheduled Tribes also appear to face particular barriers to upward mobility, and the data suggest that these stem at least in part f rom three sources: access to land, education, and regular non-farm employment. Addressing them will therefore be a vital part o f any poverty alleviation strategy pursued by the state.

Investment in poverty monitoring and evaluation important for developing a coniprelzeizsive poverly reduction strategy Developing a comprehensive poverty reduction strategy will involve more investment in poverty monitoring and evaluation (M&E). This i s not a problem particular to Tamil Nadu: it i s common to a l l o f the states in India, as it i s to most o f the developing world. Monitoring o f extant anti-poverty policies and social services more generally is, however, important if one i s to gauge whether implementation i s proceeding according to plan and achieving i t s stated objectives. The Government o f Tami l Nadu i s an ideal agent for engaging in M&E, given i t s voluble commitment to combating poverty, openness to receiving feedback, and r i ch human capital resources. Impact evaluations are most appropriate to programs which are innovative, replicable, involve substantial resource allocations, and have well-defined interventions.

The capacity to monitor the progress o f poverty and human development and link that with overall pol icy and poverty-reduction interventions remains critical. There i s also scope for aligning the various

X

programs listed in the Tenth Plan to improve coordination and targeting: many programs are not coordinated, with multiple, overlapping and sometimes different objectives.

Capacity to manage a complex and growing reform agenda reqirires strengthening. Substantial capacity building and broad-based knowledge partnerships can help address the management of reforms in priority areas such as water resources management, agriculture diversification, public expenditure management, and public-private partnerships in infrastructure financing and development.

In summary, much has been achieved but a lot remains to be done. Political economy and capacity constraints may result in temporary reform uncertainty. What i s critical i s commitment to reform, as wel l as the sequencing and prioritization o f reforms, and careful managing o f trade-offs in reform gains, costs, and risks. T o do so, i t i s important to build a broadly-shared consensus through public debate and to carefully design a minimum set of policies and programs to compensate for the impact o f reform, so as to maintain a critical mass o f support for reforms to proceed.

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I. DEVELOPhlENT OUTCOMES AND CHALLENGES

Development Outcomes

1. Mi l lennium Development Goals (MDGs). A graphical analysis o f Tamil Nadu's performance against six o f the MDGs i s presented below (Figurel.1). Tamil Nadu i s on track to meet most o f the MDGs, with trend perfonnance better than required for such important MDGs as poverty reduction, child malnutrition, school enrollment, and infant mortality. Reduction in the discrepancy o f male-to-female literacy i s slightly below the target.

Figure 1.1: Progress in Tamil Nadu toward Key Millennium Development Goals (MDGs)

i 1. Poverty Reduction I 2. sild Malnutrition (c5years)

4 . Ratio of Female toMale Literacy 3 . School Enrollment:B-IO Year-Olds i

r lffi

1987 19% BO1 2008 2015 Year

I 1 . 1 2 - I

1994 20 01 20 15

Year

5. Infant Mortality Rate

100 p

6 .Access to Safe Water

_---

1987 1994 2031 2m8 2015

1 --o--- MDG target -Tamil Nadu -Actual 1

Note: The baseline for the MDGs i s based on extrapolation from existing data to the MDG baseline year, 1990.

2. Poverty outcome. Tamil Nadu's performance on poverty reduction was above India's average in the 1990s (Figure 1.2), according to the Deaton and Dreze estimates (2002). Rural poverty in Tami l Nadu f e l l f rom 38.5% in 1993/94 to 24.3% in 1999/2000, compared with an all-India decline from 33% to 26.3% (Table 1.1). Rural poverty varied widely across regions in 1993/94. As rura l poverty has fallen, the sharp regional variation has also attenuated. Rural poverty i s the highest in the coastal north. Poverty rates in urban areas also tend to be lower than those in rural areas. Urban poverty fe l l f r om 20.8% in

1993194 to 11.3% in 1999/2000, compared with an all-India decline f rom 17.8% to 12%. Thus, compared with the all-India performance, Tamil Nadu achieved an above-average reduction in both rural and urban areas. Tamil Nadu ranks sixth out o f the 15 major states in per capita income.

HY

PJ KR GJ

Figure 1.2: Tami l Nadu’s performance on economic growth and poverty reduction

I 64% I60%

’ 145% . 14%

Growth rate of per capi ta income during the 1990’s Decline in Poverty Ratebetwen 1993194-1999100

Reduction from Reduction from 1999100 1993194 1999100 1993194 1999100

KN

GJ T N

WE

M H KR

India A P RJ

M P

Keduction from

1993194

2y-n I 4 6% I 4.6% 1

4 .2% I

j 4 “ Y O I

3.5% I -^“ I 4-

-0 7%

Note: AP: Andhra Pradesh, BH: Bihar, GJ: Gujarat, HY: Haryana, KN: Kamataka, KR: Kerala, MH: Maharashtra, MP: Madhya Pradesh, OR: Orissa, PJ: Punjab, RJ: Rajasthan, TN: Tamil Nadu, Up: Uttar Pradesh, &WB: West Bengal. Angus Deaton and Jean Dreze (2002), “Poverty and Inequality in India: A Reexamination,” Economic and Political Weekly, September 7.

Source: CSO, NSSO, Planning Commission, Census o f India

Table 1.1: State-Specific Poverty Headcount Ratios in the 1990s (YO)

3. It i s important to note that poverty estimates in India based on the 55th round National Sample Survey Organization (NSSO) Consumer Expenditure Survey have been the subject of much analysis and debate. Depending o n the specific model used to adjust for comparability between the NSSO rounds o f 1993-94 and 1999-2000, there are different estimates on the extent o f poverty reduction between these two years. The Government o f India’s estimate shows that Tami l Nadu’s poverty headcount was reduced from 35.4% in 1993/94 to 21.1% in 1999/2000. An alternative estimate based on a model postulating a relationship between poverty and household characteristics (Ki j ima and Lanjouw, 2003, a Bank pol icy research working paper) shows poverty declined from 30.3% in 1993/94 to 28.9% in 1999/00. These different models also induce variations in the rural and urban headcount rates. A resolution o f this debate i s not possible for now, since there i s n o scientific way o f determining which o f these models better reflect the “true” picture - being essentially ex post methods o f adjusting consumption expenditures to achieve comparability between the two surveys, using alternate sets o f assumptions that cannot be tested.

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However, n o matter which precise method i s used, Tamil Nadu has made progress in poverty reduction in the latter ha l f o f the 1990s.

4. Education and health outcomes. Tamil Nadu has achieved notable success in human development outcomes. It has moved from being a near-average to a high-performing state, as indicated by the Human Development Index (HDI) measured in terms o f longevity, education and command over resources. In 1981, i t s HDI ranked seventh, at 0.343, only slightly above the national average o f 0.302. By 2001, however, Tamil Nadu’s HDI rose to the third highest, at 0.531, higher than the national average o f 0.472.’ Tamil Nadu has been a pioneer in India in integrating nutrition and increasing enrollment o f children in elementary education. Education and health outcomes in the state have also improved across gender, caste, income and regional dimensions, particularly in the access to primary-level health and education services. The well-known Noon Meal Scheme (NMS), which started in 1982, covers a l l children ages 2- 15 in both rural and urban areas. The main objective o f the N M S was to ensure nutritional support to children but also to act as an effective incentive for achieving universal education. The program has been emulated by other states and has recently been viewed by the Go1 as a model.

5. Tamil Nadu’s success i s the result o f sustained economic growth and an effective human development (HD) strategy. This strategy has focused on three main areas: (i) expanding the coverage o f social services, (ii) improving quality o f the services provided, and (iii) ensuring wide participation o f the poor and other marginalized groups. A political consensus for investing in human capital by successive state govemments’ and the use o f a multi-sectoral approach to addressing human capital formation has also contributed to human capital gains.

6. Gender equity. Thirty-three percent o f seats are reserved for women in al l statutory and non- statutory committees o f the state government. Tami l Nadu’s performance with respect to female literacy, female infant mortality rate, female l i f e expectancy and fer t i l i ty rates shows that the status o f women in Tamil Nadu i s higher than in most Indian states. The Gender Development Index (GDI) for Tami l Nadu i s 0.654 (2001), as against the all-India average o f 0.560. Socio-economic empowerment o f women through the provision o f opportunities for education, self-employment and training are priorities. A key initiative i s the Tami l Nadu Women’s Development Project (Mahalir Thittam); the project supports over 187,000 Self-Help Groups, with membership o f 3.1 mi l l ion and savings o f about Rs.6 bil l ion. Moreover, owing to assistance in establishing credit linkages with financial institutions, the Self-Help Groups have been able to access credit assistance amounting to Rs.10 bil l ion.

7 . Economic growth. The liberalization in the 1990s accelerated economic growth in Tami l Nadu, increasing average real GSDP growth rates to 6.4% from 5.4% in the 1980s. Tami l Nadu’s per capita income growth ranked the third highest among Indian states in the 1990s. The faster growth o f industry and services relative to agriculture has changed the shares o f these sectors in the GSDP (Figures 1.3 and 1.4). Tamil Nadu has been one o f the most favored foreign and domestic investment destinations in India; but India as a whole has lagged behind some other countries. Tamil Nadu accounts for 60% o f merchandise exports o f four southern states, 15% o f all-India merchandise exports and 17% o f all-India IT exports; in 2001102, it exported US$6.5 b i l l ion worth o f merchandise and US$1.2 b i l l ion wor th o f IT services. IT has been Tamil Nadu’s strongest growth sector since 1997/98, growing by nearly 40% o n an annual average basis. Traditional exports, such as textiles, ready-made garments and leather goods, have grown by only 3-6% on an annual average basis over the same period.

8. Economic growth has slowed since the late 1990s. The slowing i s mainly the result o f a decline in agriculture largely o n account o f three statewide droughts and their spillover impact o n other sectors (see para. 17 for analysis).

National Human Development Report, 2001, Planning Commission, Government o f India.

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Table 1.2: Rural Poverty Incidence and Shares by Land Ownership among SC/ST’s

Quintile Cultivation

NSSO Round sotb 551b % o f rura l % o f rura l

Ext reme Poverty SCiST % share o f % share Ext reme Poverty SCiST % share o f % share Pover ty Incidence populat ion extreme o f the Poverty incidence populat ion extreme o f the

Inc idence poor poor incidence p o o r p o o r

N o land 24 47 27 23 24 21 40 17 11 12 >O & ?0.4 ha 3 1 57 57 62 61 32 58 71 71 73 >0.4 & ? 1 h a 33 56 10 12 11 53 74 8 13 10 >1 & ? 2 h a 21 45 4 3 3 40 70 3 4 4 > 2 & ? 4 h a 0 11 2 0 0 17 50 1 0 1 >4 h a 0 0 0 0 0 0 1 0 0 0 overal l 28 53 100 100 100 32 57 100 100 100

Note: (1) Extreme poverty i s defined as per capita consumption rank <20% in the total consumption distribution. (ii) Poverty i s defined as per capita consumption rank <40% in the total consumption distribution.

Agriculture Non farm Non farm Self Non farm Total Non Other Real Per wage Labor wage Labor employment Regular farm sources Capita

Employment sources Income Rs.

11. Rural poverty i s concentrated among those with marginal landholdings and dependent on rain-fed agriculture. As one moves f rom the lowest- to the highest-income quintiles o f rural household income, the contribution o f agricultural wage income to total income decreases monotonically, while that o f cultivation and non-farm sources increases monotonically (Table 1.3). Reinvigorating agriculture growth and accelerating industrial growth, together with solid growth in the tertiary sector, remain critical for sustained poverty reduction. Data limitation prevents a fuller understanding o f urban poverty.

12. Important challenges in the non-income dimensions o f poverty remain. High drop-out and l o w completion rates continue to reduce the effectiveness o f Tamil Nadu’s secondary education program. Completion and drop-out rates s t i l l mask disparities across the state (Figure1.6). For example, about 15 percent o f students drop out at the primary level, nearly a third by elementary school, nearly three-fifths prior to completing Grade X (or SSLC) and about three-fourths by Higher Secondary. There are s t i l l gender, caste, inter-distnct, and urban-rural disparities. The gender gap in education i s especially larger among poorer households. Scheduled castes and scheduled tribes also have significantly lower educational attainment than non-scheduled casteshcheduled tribes.

5

I

h

15. The increasing reliance on borrowing to finance growing recurrent expenditure steadily increased the state’s debt burden. The debt-to-GSDP ratio climbed from 16.2 percent in 1997198 to 28 percent in 2002/03. The ratio o f debt to revenue receipt increased from 125 percent in 1997198 to 212 percent in 2002103. Debt accumulation resulted in rapid increase in interest expenditure. Furthermore, guarantees as a percent o f GSDP rose to support the market borrowing o f public enterprises. Adding guarantees to explicit public debt, the maximum liabilities o f the Government as a percent o f GSDP increased from 2 1.4 percent in 1997198 to about 34 percent in 2002103 (Figure 1. 9).

40.0% 1 Figure1 9 : Debt and Guarantees

0 Debt I Guarantees

Source : GoTN’s Budget Documents

16. The rapid fiscal deterioration i s attributed mainly to: (i) rapid growth o f expenditures on salaries, retirement benefits, and pensions, following the implementation o f the Sixth State Pay Commission award along the lines o f the Central Fifth Pay Commission’s award (the previous state Government implemented, in 1998, the award with retroactive effect to 1996); (ii) a growing burden o f subsidies (particularly food subsidy); (iii) a further decline in Tamil Nadu’s share in central tax devolution following the Eleventh Finance Commission’s award; (iv) a growing debt and interest burden arising largely f rom increased borrowing to support the growing revenue deficit; and (v) higher contingent liabilities associated with fiscal support to the public sector units, cooperatives, and the statutory boards. I t must be recognized that these systemic factors were undercurrent even before the crisis, and the implementation o f the Sixth State Pay Commission’s recommendations triggered the fiscal r isks. The fiscal crisis has been a factor in the state’s ability to respond to recent growth slowdown and real growth in capital outlay has been negative in the period since 2000/01.

17. Challenges o f accelerating economic growth. Growth slowed f rom an annual average o f 6.6% from 1990/91 to 1998/99 to an annual average o f about 3.7% from 1999100 to 2002103. Much o f the recent slowdown i s attnbuted to the impact o f the droughts on agnculture and their spillover to other sectors. Tamil Nadu’s agnculture i s vulnerable to periodic droughts due to i t s dependency on rainfall. More frequent than in the recent past, three annual droughts including the century’s worst statewide drought in 2002, led to an annual average o f -3.9% growth during 1999/00-2002103 compared with an annual average o f 4.5% in the previous nine years. Despite vulnerability to droughts, Tamil Nadu’s agriculture has done better than the Indian average in growth and productivity in the past two decade^.^ The weak performance in the agriculture sector has spilled over to the service and manufacturing sectors whose growth has also recently slowed down.

In 1998-99, Tamil Nadu had the highest rice, sugar cane and groundnut yields in India and cotton yields in the state were second only to Gujarat. Increases in yields enabled land productivity to grow by 6.1 percent per year between 1987188 and 1993/94 from Rs 16,423iha to Rs 23,459ha (in constant 93/94 Rs), but by only 2.4 percent per year between 1993/94 and 1999/00 (to Rs 27,099iha in constant 93/94 Rs). Likewise, average labor productivity in agriculture increased by an average o f 4.6 percent per year between 1987188 and 1993194 from Rs 6,881 per worker to Rs 9,024 per worker (in constant 93194 Rs), but by only 2.4 percent per year between 1993194 and 1999100 to Rs 10,434 per worker (in constant 93/94 Rs).

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18. Although droughts are exogenous shocks, there are structural impediments, overcoming which could put economic growth on a higher trajectory path o f 8% targeted by the GoTN to accelerate the pace o f poverty reduction. Tamil Nadu’s agriculture faces challenges o f growing water scarcity, land - degradation, decline in farm sizes, and rising cost o f agricultural labor. &gid labor regulations, a complex and cascading indirect tax system, protracted exit and bankruptcy procedures, and infrastructure deficiencies are among the key constraints to better manufacturing performance in India.4 The 2003 investment climate survey o f the manufacturing sector in Tamil Nadu reaffirms this assessment.’ Although manufacturing i s recovering in India and in Tamil Nadu,6 higher and sustained manufacturing growth requires second-generation reforms to improve the investment climate.

% o f Economically Tamil Andhra Kamataka Kerala Active with Primary Nadu Pradesh

Employment in:

19. Higher manufacturing growth, together with the growth o f the service sector, i s critical to absorbing surplus agriculture labor and reducing rural poverty. The primary sector accounts for 50% o f total employment, industry accounts for 24%, and the tertiary sector accounts for 26%. Tamil Nadu has had higher rural non-farm employment than other Indian states (Table 1.4), and industrial activities are more spread across the state than most Indian states. Non-farm activities-manufacturing and services- account for about 50% o f rural household income (Table 1.3). Faster expansion o f the manufacturing and service sectors would help reduce the impact o f seasonality o f rural employment, with acute vulnerability during the droughts, on rural incomes.

All-India

labor Source: NCAER Human Development Survey 199314

Reform Agenda

20. Achieving fiscal correction and stabilization. The most immediate challenge that faced Tami l Nadu in 2001/02 was to reverse the rapid fiscal decline and create fiscal space for development spending. With salaries and pension o f govemment employees (accounting for 2% o f the state’s population)- accounting for government’s entire own revenue during the crisis, or salaries, pension, interest, and subsidies accounting for 94% o f the state’s total revenue, there was litt le fiscal space lef t for essential infrastructure and social spending. In fact, about 70% o f the ne t borrowing o f the state govemment in

T h e World Bank and the Confederation of Indian Industries, 2002, “Competitiveness of Indian Manufacturing Results from a

T h e World Bank and the Confederation o f Indian Industries, Second Indian States’ Investment Climate Survey, 2003. T h e increase in new investment commitments in manufacturing from April 2001 to April 2003 was highest in Tamil Nadu

Firm-Level Survey.”

compared with other major Indian states, based on data from the Center for Monitoring of Indian Economy.

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1999/00 was for debt repayment. The resultant liquidity crisis, led to accumulation o f arrears that reached 1.7% o f GSDP in 2000101 and 2% o f GSDP in 2001/02.

2 1. The then newly elected Govemment tabled a White Paper in the state legislature in August 200 1. I t analyzed the systemic causes o f the fiscal deterioration, and served as a plat form to launch a fiscal reform program. To quote the White Paper, “Without a firm commitment to fiscal discipline and prudent management o f State finances, n o Government can fulfill the mandate to it by the people.”

22. Over the next two years, the government ambitiously embarked on reforms touching a number o f areas in both revenue and expenditure. I t proceeded to do so at a rapid pace to catch up with other reforming states such as i t s neighbors Andhra Pradesh and Karnataka. Some o f the reforms were bold and path breakmg both in the context o f the past history o f the state, such as the Public Distribution System or agriculture power tariff, and in the national context such as pension reforms. The reforms were undertaken, notwithstanding a diff icult economic environment posed by successive droughts and the l o w economic growth. Significant gains were made over the next two years and aggressive fiscal reform targets were set for the future. These would have enabled improvement in spending efficiency by making fundamental changes to the way the budget was prepared and executed. By attempting expenditure reallocation the program sought to improve growth and human development achievement.

23. But negative electoral results in the national elections in Apri l -May 2004, in the state, brought about a number o f policy changes involving significant rollback o f key policy reforms. What followed was a series o f quick reversal o f significant reform measures (power, PDS and reintroduction o f free bus passes for students and other user charges), adding increased fiscal cost to the budget making it more diff icult in the future to retum to the policy reform path. The fiscal reform effort suffered a setback jeopardizing the realization o f the projected medium-term fiscal adjustment and expenditure restructuring in the Medium-Term Fiscal Program.

24. Critical elements o f the fiscal reform program included: the development o f a multi-year framework for fiscal adjustment; improving legislative oversight and fiscal transparency; restructuring high-cost public debt and management o f guarantees; improving the efficiency and equity o f the tax administration and rationalizing user charges; reorienting expenditure f rom current consumption to growth-enhancing and poverty-reducing investment; reforming state-owned manufacturing enterprises and ail ing cooperatives; and strengthening public expenditure management and financial accountability to increase the efficiency o f public spending.

25. The most challenging part o f the fiscal reform program continues t o remain restructuring spending on salary and pension and o n explicit and implicit subsidies. The challenge i s compounded by the constraint on increasing revenue resources.

26. Improving investment climate for manufacturing and services. Recognizing the role o f the private sector as an engine o f economic growth, the Government has put emphasis o n streamlining complex government regulations over private investment and production, and o n strong partnership with the private sector for sustainable infrastructure financing and development. Tamil N a d u i s at the forefront o f such partnership with a number o f pilots that are the f i rst in India (Box 1.1). The critical ro le o f the private sector i s facilitated by increasing recognition o f the positive role o f the private sector in infrastructure development; i t i s also necessitated by the fiscal crisis and the large backlog in infrastructure investment and maintenance.

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Box 1.1: Public Private Partnership in Infrastructure Service Delivery

e The Tirupur Water Supply Scheme, the first water sector related project developed under the PPP framework in India. After a gestation period o f almost 10 years, GoTN accelerated and completed legal, financial and management agreements between July 2001 and March 2003. The construction i s on schedule. A total o f Rs.45 crore equity and subordinated debt financing from GoTN has leveraged additional equity financing o f Rs.217 crore and leveraged a debt o f Rs.700 crore including financing from Tirupur Exporters Association and foreign investors. The project will supply water to the fast-growing garment export industry in Tirupur, domestic consumers in Tirupur Municipality and surrounding villages, as well as a sewerage system for the Tirupur Municipality and onsite sanitation facilities for slums. User charges are based on cost recovery with cross subsidies between industrial and domestic consumers.

e The Alandur sewerage project is the first such project in India using a PPP framework (BOTformat) to provide underground sewerage to a town o f 125,000 people near Chennai. Public awareness and support was sought through an extensive communication campaign. Some 15,000 households out o f 17,000 have contributed Rs. 5,000 per household representing one third o f the project cost. A notable feature i s the tariff structure, developed on full user charge recovery with cross subsidies for the poor. The first community participation project, has also suffered a number o f set backs due to some lack o f forward planning, i.e. delays in selection o f an operator for O&M o f the sewerage scheme; miscommunication on the distinction between upfront payment o f capital cost through community participation and a separate connection fee to each house to be levied separately. These are lessons, which can be incorporated in repeat o

The East-Coast Highway Project on road upgrading, Tamil Nadu Road Development Company (TNRDC) was set up in 1998 to catalyze private sector investment in the road sector and commercialize O&M. I t s equity o f Rs. 10 crores was split 50:50 between public and private funds. The f i rs t upgrading project financed by TNRDC i s the 113 Km. long East Coast Road (ECR) connecting Chennai and Pondicheny at a cost o f Rs 60 crore. A Rehabilitate-Improve-Maintain-Operate-Transfer (RIMOT) framework was applied and commercial operations on the road commenced in March 2002. The RIMOT framework requires user charges to recover improvement and maintenance costs only, leading to lower tolls; project returns are capped at 20% and surplus if any, i s reinvested in the road sector in Tamil Nadu.

Tamil Nadu Urban Development Fund (TNUDF) for credit enhancement capital market financing of urban infrastructureprojects. Financed through a World Bank Loan, GoTN Line o f Credit, and equity from banks in 1996, the Fund had approved loans o f Rs.492.27 crore as o f March 2003. Notable projects ar adurai Ring Road, and Pooled financing for smaller towns for wat

e

e

ste contracts and storm TNUDF has structured investments g capabilities o f Urban Local Bodies acity enhancement o f ULBs. The few privately contracted projects have so far

had a good track record o f implementation. TNUDF lends to ose ULBs which are recePtive to undertaking institutional and financial reforms.

es on the basis o f in technical and

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27. Reinvigorating agriculture growth. This remains critical since a vibrant agriculture sector encourages industrial growth and farm income accounts for 78% o f the income o f the poorest 20 percent o f the rural population. Traditional sources o f agncultural growth, however, face major constraints including growing water scarcity, increasing land degradation and declining farm sizes, and rising costs o f agricultural labor (Box 1.2). Given water scarcity, diversification into less-water intensive higher-value products i s the most promising avenue for future agncultural growth. Broader institutional and policy reforms are required to efficiently manage scarce water resources, decentralize a traditionally top-down centralized extension system to respond to diversified agriculture, improve rural infrastructure to facilitate efficient markets, and reorient public expenditure towards growth-enhancing areas such as rural roads, markets and agricultural research and extension. This requires to be combined with appropriate levels o f cost recovery for water, power and other inputs and safety expected loss o f farmers' income in the transitional period.

Box 1.2: Challenges to Sustaining Agriculture Growth in Tamil Nadu

Tami l Nadu i s one o f the driest states in India, with an average o f only 925 millimeters o f rainfall per year. The state has a dry season that extends over five months o f the year (January through May) even in good years, and severe droughts occur in three out o f every ten years severely limiting cultivation o f crops between the months o f June and September. The per capita availability of water resources o f Tami l Nadu i s only 900 cubic meters compared to an all-India average o f 2200 cubic meters per annum. Irrigation through a combination o f canals, tanks,' and wells, increases the reliability and availability of water for farming, and i s essential for successful cultivation o f crops in much o f the state. Nonetheless, seasonality o f supply and scarcity o f water limit cultivation to only one crop per p lo t for most o f the state.' In addition to growing water scarcity, the agricultural sector faces increasing competition for water f rom industries and domestic users and intensifying interstate competition for surface water resources. In many parts of the state, the rate o f extraction o f groundwater has exceeded recharge rates contributing to falling water tables. Water quality issues are also o f increasing concern. Effluents discharged from industries as we l l as heavy use o f pesticides and fertilizers have had a major impact on surface water quality, soils and groundwater.

Agricultural land resources have also come under increasing pressure because of rapid population growth and increasing urbanization. The available cultivable land per rural resident has declined from 0.22 hdcapita to 0.15 hdcapita between 1971172 and 1997198. The growing pressures o n land coupled with skewed pricing policies and rural poverty have contributed to land and soil degradation. As a result, poor soil fertility, salinity, water logging, over grazing, and deforestation are growing problems and pose serious constraints to the performance o f the agricultural sector in some parts o f the state.

I Source: Tamil Nadu Agncultural Development, Wor ld Bank (2004)

28. Improving public administration and enhancing service delivery. Although Tami l N a d u has one of the better records in public administration and service delivery among Indian states, the state i s not immune to problems common across Indian states. T o support the fiscal reform and the reform o f the investment climate, the reform would also need to focus o n strengthening the effectiveness o f the government by rationalizing i t s role and responsibilities, simplifying decision-making processes, improving the stability o f staff tenure, and enhancing critical services delivery-which have a large public interface through a combination o f measures such as agency reform, e-governance, and public private partnerships. Further, the reform would need to address the transparency o f the government and

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anti-corruption, through a major overhaul o f the public procurement system, enacting n e w “Right to Information” legislation, and strengthening the anti-corruption machinery (Box 1.3).

Box 1.3: Some important Governance and Service Delivery Challenges in Tamil Nadu

Tamil Nadu has registered some o f the best human development indicators in India after Kerala. A recent survey conducted by Bangalore’s Public Affairs Center (PAC) reveals that it possesses the country’s best public distribution and school education systems, and the second best public drinking water and road transport services after Gujarat. This, o f course, i s not a uniform picture: health services, for example, are ranked fifth. One key issue i s the proliferation o f the bureaucracy which has grown exponentially in the last twenty years. In order to get a grip on the problem, GoTN appointed a Staff and Expenditure Commission (SERC) to suggest ways o f reducing the size o f the c iv i l service. SERC has submitted al l i t s reports, which pinpoint redundant positions in Tamil Nadu’s 140 field departments, as well as the Secretariat; recommend strategies for rightsizing, such as redeployment, compulsory retirement, and a targeted form o f VRS; and proposes broader reforms to enhance efficiency, such as faster file movement, more delegation to field offices, and outsourcing several tasks. T h e civi l service faces a problem o f fiequent transfers that undermine service delivery by disrupting managerial continuity and generate corruption. This i s also a national phenomenon and different states have attempted to tackle it in different ways. For instance, GoTN has responded to th i s problem by introducing a system o f formal counseling for transfers in both the Health and Education Department to reduce discretion in the process. But further steps could be taken, particularly l e ation to ensure a normal t e r m o f three year place quantitative l imi ts on transfers in the aggregate and by cadre, and create statutory boards andor transferring authorities to better streamline the transfer process. A database to systematically monitor transfers i s necessary. Tamil Nadu was the f i rst state to pass a comprehensive law to regulate procurement and ensure access to information. The procurement law is sound and GoTN has recently begun further reforms, such as creating standard bidding documents and harmonizing codes and rules across government wi th the procurement law. Tamil Nadu was also the first state in the country to adopt a Right to Information (RTI) law in 1997: The law, however, was seriously flawed and GoTN has now decided to replace i t with a new and better law. GoTN has also used i t s website to provide a wealth o f information to the public, including Government Orders, laws and rules, and information on departments and agencies. On the other hand, Tamil Nadu’s anti-corruption institutions need strengthening. GoTN’s H igh Level Committee on Administrative Reforms and the Prevention o f Corruption in i t s 1997 report recommended the creation o f an independent Vigilance Commission. The best example o f a successful independent anti-corruption institution i s Karnataka’s L o k

ases and grievances arising ters; exercises supervisory

the police wing , and possesses a

authority to investigate both c ation involving c iv i l servants

Source: Tamil Nadu: Governance Challenges. World Bank. 2004.

29. Strengthening poverty monitor ing and evaluation. The broad structural r e f o r m program needs to b e supported by protecting the poor and vulnerable through targeted interventions. T h e Tenth Five-Year P lan provides a detailed description o f the poverty-reduction programs, w h i c h are w ide ranging, t o cover health, education, water supply and sanitation, and food security. These programs include schemes targeted to particular social and demographic groups such as scheduled castes and tribes, women and children. The specific interventions broadly match the spatial and social needs revealed by the poverty

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diagnostics although there i s scope for improving the design and targeting efficiency. T o this end, strengthening poverty monitoring and evaluation for effective targeting i s an important focus area. For example, developing strong institutional capacity for evaluation based leaming i s invaluable for improving the targeting in schemes such as the Public Distribution System. Similarly, building institutional capacity for an effective monitoring and feedback mechanism that ensures aligning o f budgets to priority needs in education, health and broader aspects o f service delivery will be important in the coming years.

30. Impact o f reform on growth and poverty:

0 Fiscal correction and sustainability can exert a positive impact on economic growth and poverty reduction in four ways: (i) by reallocating public expenditures f rom consumption to growth- enhancing and poverty-reducing productive spending; (ii) by strengthening public expenditure management to help increase the efficiency o f public spending; (iii) by achieving a sustainable and transparent fiscal environment and increased spending o n infrastructure that encourages private investment, including private spending on critical infrastructure and basic services; and (iv) by creating and protecting the fiscal space for the various targeted poverty-reduction programs envisaged in the Tenth Plan.

0 Streamlining business regulations and improving infrastructure will improve the investment climate for private sector development. This particularly benefits medium and small enterprises as complex regulation and infrastructure bottlenecks tend to disproportionably affect smaller businesses. The acceleration o f economic growth led by the private sector remains fundamental to poverty reduction.

0 The reform component o f public administration and service delivery wil l help address issues o f common concem for al l critical infrastructure and service delivery sectors relevant to poverty reduction. Streamlined government functions, simplified decision malung, the stability o f staff tenure, and transparency and anti-corruption measures would a l l contribute to improved service delivery and poverty reduction.

0 The government’s strengthened capacity to manage the reform process-including the capacity to evaluate and monitor major poverty-reduction interventions and link policy, expenditure and poverty reduction-will help strengthen targeted poverty-reduction interventions to the poor and disadvantaged groups.

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11. ACHIEVING FISCAL CORRECTION AND STABILIZATION

Tamil Naclu’s Fiscal Reform

3 1. Facing an unprecedented fiscal crisis, the Government o f Tamil Nadu launched a program o f fiscal correction and stabilization in 200 1. T o quote the August 2001 Whi te Paper o f the Government o f Tamil Nadu: “Without a firm commitment to fiscal discipline and prudent management o f State finances, n o Government can fulfill the mandate to it by the pe0p1e.l’~ The White Paper, tabled and debated in the state legislature, analyzed the systemic causes o f the fiscal deterioration and articulated the need for fiscal reform and stabilization. Substantive reforms were undertaken from late 200 1/02 to 2003/04. However, electoral defeat in the national election in Apnl -May 2004 led to the rol l ing back o f reforms. The rollbacks have resulted in: free power being restored to al l farmers, substantial reduction in electricity tar i f f for domestic consumers, restoration o f freeisubsidized bus travel to private school and college students, and withdrawing PDS targeting by imposing income ceiling and rice coupons in favor o f universal coverage. Minor ones have included withdrawing hospital visiting fees and outpatient charges. I t i s uncertain how far the ro l l back would go. The rollback o f key subsidy reform policies mean the government’s projected medium-term fiscal adjustment will prove diff icult to achieve unless policy reforms that underpinned the M T F P are persevered with.

32. Paragraphs below summarizes critical elements o f the fiscal reform: the development o f a multi- year framework for fiscal adjustment; improving legislative oversight and fiscal transparency; improving the efficiency and equity o f the tax administration and rationalizing user charges; reorienting expenditure f rom current consumption to growth-enhancing and poverty-reducing investment; reforming state-owned enterprises and ailing cooperatives; and strengthening public expenditure management and financial accountability to increase the efficiency o f public spending.

33. Development o f a medium-term fiscal program. The annual budget o f the state Government, as in other states, did not reflect a medium-term perspective. The budgeting process was an incremental exercise with n o clear links between policies, budget, and outcomes. Fiscal accounting, being o n the mandated cash system, did not fully capture deterioration in the fiscal condition, owing to non-reporting o f accrued liabilities (arrears and nonpayment o f actual expenditures as in 1999/2000, 2000/01, and 200 1/02) and contingent liabilities, such as guarantees. Financial losses of the state-owned enterprises were not consolidated with the state government’s accounts, which therefore provided an incomplete picture o f the underlying fiscal trend.

34., The state legislature enacted a Fiscal Responsibility A c t in M a y 2003, the third Indian state to do so. T h e Ac t set fiscal targets for reducing the budget fiscal deficit to 3% o f GSDP and the revenue deficit to revenue receipts to a level below 5% by March 3 1, 2008, and capped risk-weighted guarantees at 75% o f revenue receipts o f the previous year, or 7.5% o f GSDP. The G o T N also signed a Memorandum o f Understanding (MOU) with the Go1 o n the State’s Fiscal Reform Facil ity in September 2003, which set a path for sustained reduction in the ratio o f the revenue deficit to revenue receipts.

35. Guided by the Fiscal Responsibility Act, the Government o f Tamil Nadu developed a f i rs t medium-term fiscal program (MTFP), a five-year framework, which was envisioned to be an annual ro l l ing document institutionalized into the budget formulation process. The f irst MTFP was presented to the state legislature in February 2004, along with the state’s budget for 2004/05. Subsequent MTFPs

’ White Paper on Tamil Nadu Government’s Finances, Government o f Tamil Nadu, August 2001.

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were envisioned to be presented with subsequent annual budgets, along with reports on performance against targets.

36. The MTFP explicitly incorporated important off-budget activities and other contingent liabilities into the multiyear adjustment framework. First, the accounts o f the Tamil Nadu Electricity Board were consolidated with the Government’s budget to arrive at a consolidated deficit. Second, off-budget borrowing serviced by the Government o f Tamil Nadu was integrated with the state’s public debt.8 Third, capital work executed from the Public Account but financed from off-budget borrowings through Public Deposit Accounts, thus distorting the fiscal deficit, were fully integrated within the fiscal framework. Fourth, comprehensive and robust estimation o f accrued pension liabilities and emerging cash f low needs based on the inherent demographics o f the workforce replaced ad hoc incremental budgeting.

37. The process i s not complete and steps need to be taken to further improve fiscal transparency. The current practice o f reporting cash deficits by Indian states limits the scope for reporting accrued liabilities. The fiscal deficit and i t s financing need to be consistent with international practice. Budget documentation needs to be improved to present departmental pol icy objectives, major programs, performance goals, and associated funding, together with subhead- and program-level budget estimates for department grants. All essential fiscal information will need to be posted o n the Web for public access, including the Accountant General’s fiscal accounts for the state, with supplementary comments on guarantees, payment arrears, off-budget borrowings, accounts o f the state-owned enterprises, and the outcomes o f periodic reviews o f subsidies. The Government has begun tabling a bi-yearly review o f the budget in the state’s legislature, which has also been publicly released o n the Government’s website.

38. Prudent management o f guarantees i s an essential part o f the medium-term fiscal adjustment. The 2002/03 budget classified and reported guarantees by risk weight for the f i r s t time. The next step would be to establish an institutional framework for screening competing demands for the issue o f guarantees while staying within the limits set by the Fiscal Responsibility Act.

39. The MTFP i s underpinned by a continuation and deepening o f taxation and expenditure reform, and reforming state-owned enterprises and cooperatives to reduce subsidies and liabilities. But recent decisions extending free power to al l agriculturists, slashing power tar i f f to domestic consumers to pre- reform levels o f 2001 (expected to cost government about Rs. 920 crore in 2004/05), withdrawal o f PDS targeting (will raise food subsidy by about Rs. 130 crore in 2004/05), restoration o f transport subsidy (student bus passes & concession fare will cost Rs. 125 crore in 2004/05), constitute reform setbacks. They bring into question the validity o f the MTFP and the commitment o f the government to fiscal reform.

40. Reforming the taxation system. The potential for substantially increasing the tax revenue in Tamil Nadu i s l imited for three reasons. First, Tamil Nadu’s own tax revenue effort i s already among the highest in Indian states. Second, India’s Constitution places limitations o n the taxation power o f states. The fastest growth sector in Tamil Nadu i s the services sector, taxation o f which i s reserved for the central Government. Third, successive central Finance Commissions have reduced the share o f Tamil Nadu in the pool o f net shareable central taxes, from 8 percent (Seventh Finance Commission) to 5.4 percent (Eleventh Finance Commission). The contribution o f the share o f central taxes to Tamil Nadu’s revenue declined from 2 1 percent in 1992/93 to 15 percent in 2002/03.

41. There is, however, considerable scope to improve the efficiency, equity, and administration o f the state tax system (Box 2.1). In particular, the state’s sales tax (63 percent o f the state’s own revenue)

The stock o f off-budget borrowings in the public account, though unsubstantial relative to other states’ (for example Kamataka and Maharashtra), constituted 2 percent o f 2002103 GSDP.

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consists o f sales tax, entry tax, resale tax, additional tax, and surcharges, which imposes high effective tax on inputs with no rebates and results in a negative cascading impact on manufacturing costs. The entry tax on goods into local areas from outside Tamil Nadu negatively affects trade and investment. The relatively high stamp duty on immovable property encourages evasion and value under-reporting in property transactions. The tax administration imposes high compliance costs because o f i t s lack o f self- assessment for large businesses, lack o f electronic filing, and protracted dispute resolution procedures, which encourage undesirable frequent contacts between businessmen and tax officials.

42. T o provide an overall policy framework for reforming tax policy and administration, the Government established a Tax Reform and Revenue Augmentation Commission in June 2002, headed by the well-known Dr. Rajah Chelliah. The Government has begun implementing key recommendations o f the Commission (e.g., the stamp duty o n immovable property). The introduction o f the VAT to replace the current sales tax system should resolve the main problems related to the state’s sales tax system. Tamil Nadu i s at an advanced stage of preparing for the introduction o f the VAT set for national introduction o n April 1,2005.

43. On the next important reform area, the Government o f Tamil Nadu has reduced the stamp duty on immovable property to a uni form 6 percent, from 8 percent in urban areas and 7 percent in rural areas. The transfer duty o n immovable property, which was set at a uni form 5 percent, has also been reduced to 2 percent. The effective stamp duty i s hence a uniform 8 percent, down from 12-13 percent. T o identify measures to maintain revenue neutrality following the rate change, the practice o f duty avoidance and evasion schemes and the impact o f the reduced rate o n conveyance o f immovable property on revenue collection wi l l need to be reviewed. Reforms also need to be planned for other taxes and duties (such as stamp duties o n other dutiable instruments) based o n systematic review o f these taxes, takmg into consideration efficiency, equity, and collection costs.

44. Excise revenues are derived mainly f rom privilege fees o n Indian-made foreign spirits, excise duties, and fees on liquor. The Tamil Nadu State Marketing Corporation has the exclusive right o f wholesale and retail supply o f Indian-made foreign spirits for the state and i s responsible for collecting the excise duty. The overall tax burden on liquor i s high but largely comparable with those in other states in India. Given that Tami l Nadu maintains a .public monopoly responsible for collecting excise duty directly f rom a small number o f distilleries, there i s n o evidence that the high effective tax rate induces widespread evasion that would put the revenues on the wrong side o f the Laffer curve. Reforms could be envisaged regarding the calculation o f excise duties, switching from a specific to an ad-valorem excise, following the Maharashtra example.

45. Entry taxes on motor vehicles and goods risk having an unintended negative impact on trade and investment. They hinder inter-state trade, induce a high-cost state economy, and negatively affect the competitiveness o f Tami l Nadu as an investment location. As a revenue source, they are insignificant and are justified primarily as an additional means o f fostering sales tax compliance. The business community in Tamil Nadu has asked that the entry taxation be abolished once the VAT i s introduced. This request i s fully justified.

46. Building on the ongoing efforts to improve the tax administration, a medium-term action p lan i s being formulated to reform the tax administration. I t focuses on improving corporate planning, strengthening human resources, and restructuring the tax administration, moving it f rom focusing o n enforcement to service-oriented compliance. Annex I has details o f a suggested plan for improving Tami l Nadu’s Tax Administration.

47. Improving non-tax revenue. Revenue collection in Tami l Nadu relies primarily on the state’s own tax system (70 percent o f total revenue). Another 15 percent o f revenue comes f rom shared central taxes devolved to Tamil Nadu. Only 7 percent o f total revenue i s f rom non-tax revenue. Tami l Nadu

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ranked l o w in non-tax revenue relative to 14 major Indian states (1985-2000). Some user charges (such as bus fare) do not go directly to the state’s treasury but are collected by state-owned enterprises, and regular revisions o f these charges could reduce the required budgetary support. Although l o w non-tax revenue indicates the potential for increases, such decisions are frequently constrained by political difficulties.

Source: Tamil Nadu: Improving Investment Climate, World Bank, 2004

49. Reforming the pension system and rationalizing salary expenditure. Tami l Nadu has the highest number o f c iv i l servants per hundred people o f any major Indian state after Punjab: 2.13 compared with

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1.4 for the country as a whole. W h i l e the roots o f overstaffing can be traced to decisions made in the 1980s, i t s negative impact on the current salary and pension structure adds to the current fiscal stress. As a result o f implementing in April 1998 the Sixth State Pay Commission, pension and salary growth accelerated and appropriated an ever larger share o f the state’s revenue in 199912000: 56 percent o f the state’s revenue expenditure, 68 percent o f the state’s total revenue, and 9 1 percent o f the state’s own tax revenue. Worse, these shares underestimate real liabilities, as a liquidity crisis in 1999/2000 forced the Govemment to postpone sizable payments o f salary and pension (Rs. 1,823 crore to employees who retired between January 1996 and March 1998) for five years. The present Govemment started to clear these dues in 2003104.

50. T o address the rapid growth o f salaries and pensions, the most serious threat to fiscal sustainability, the Government adopted a number o f measures. A Staff and Expenditure Reform Commission was established in December 200 1 to systematically identify surplus positions, posts, functions and departments for redeployment and streamlining (Box 2.2). The Commission has identified about 85,000 surplus posts and 113,000 vacant positions, while 10 departments have been identified for closure. The Commission’s reports o n 140 departments and agencies are under review.

Box 2.2: Staff and Expenditure Reforms Commission

There are four key features o f the SERC’s working that bear comment. First, the SERC experience i s fundamentally an in-house assessment o f redundancy, un l ike the externally-driven assessments conducted by consultants supervised by the Administrative Reforms Commission (ARC) in Kamataka, the Institute o f Public Administration in Punjab, and consultants in Orissa. Second, the SERC reports, which focus on both the Secretariat and 140 field departments provides the most targeted identification o f surplus posts in any state that has attempted such an exercise, far more pin-pointed than the externally-conducted analyses in Kamataka, Punjab, and Orissa, which have proven less useful in identi f jmg opportunities for pruning staff. The criteria for regarding a post as surplus include: (a) assessing posts in relation to existing work norms, (b) establishing new work norms in the light o f technological change, and a concomitant reduction in staff, (c) analyzing whether a department needs to perform a particular function at t h i s time and adjusting staff size accordingly, and (d) reducing posts by promoting outsourcing across government. The Commission pared about 23% o f all Group A posts, which constitute only 1.7% o f the core c iv i l service (excluding non-pensionable employees); 12% o f Group B posts (10.04% o f core), 9% o f Group C posts (75.3% o f core), and 40% o f Group D (13% o f core). Staff cuts were thus highly disproportionate for Groups A and D and mildly so for Group B; Group C, including a large contingent o f teachers, faced only a small cut relative to i t s share o f the c iv i l service. Third, the process o f formulating the reports was marked by extensive consultation. The SERC reviewed approximately 10 departments a month; for each department, the process involved an init ial round o f consultation with the Secretary and Departmental Heads (HOD’S), followed by intensive discussions with lower-level officials and unions, and a concluding wrap-up session with the Secretary. Staff associations were asked to fill out a separate questionnaire asking them to evaluate the merits o f the single-file system and level-jumping; identify areas for decentralization o f authority within departments; re-evaluate work norms in the light o f new technology; indicate areas o f excess or inadequate staffing; ctions best done only by government, by government and NGO’s or the private sector e private sector alone. Staff Associations were also asked to suggest ways o f re tive costs generally. The Commission received hundreds o f suggestions on rationalization from the public via i t s website. The expert prob Chairman in in-depth interviews with department officials, h igh and low-level, c derived from the questionnaires, yielded inside information on redundant and/or conferred legitimacy on the exercise.

Source: Tamil Nadu Governance Challenges, World Bank 2004.

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5 1. A ban has been imposed on the creation o f new posts and a freeze declared on the creation and filling o f vacancies through direct or compassionate appointments, except for essential staff (teachers, health workers, police). In another move, 23,123 l ive posts (road gang workers and people’s welfare workers) were abolished. After the Commission’s review, the Government issued orders to abolish 40,500 surplus posts in vacant positions created by the hiring freeze. The remaining surplus posts are to be abolished over the next few years mainly through attrition and redeployment o f staff. The Government also rationalized employee compensation and benefits by withdrawing surrender leave encashment and the annual Pongal Bonus, and has delayed the announcement o f additional Dearness Allowance installments (always with prospective effect). However, in a recent setback (post national elections) the Government decided to retain the services o f 15,500 temporary employees who were recruited during a c iv i l servants’ strike in 2003 malung further employee restructuring efforts more diff icult.

52. The Government also carried out pension reform to reduce current and contingent pension liabilities: a defined contribution system for employees hired after April 1,2003, has been introduced, the qualifying tenure o f service required to receive full pensions has been increased by three years, and the basis for calculating eligible pensions was changed to the last 10 months average pay rather than the last drawn pay. The Government o f Tamil Nadu has carried out a massive exercise to collect data and project pension liabilities and cash flows under the various retirement programs, not on ly for the state c iv i l service but also for local bodies and major state-owned entities such as the Tamil Nadu Electricity Board and the State Transport Corporations.’ This has enabled a comprehensive and robust estimation o f pension liabilities and emerging cash f low needs, which take into consideration the demographics o f the workforce.

53. The Government o f Tamil Nadu has already issued a Government Order establishing a new defined contribution scheme for al l c iv i l servants hired with the status o f pensionable service after April 1, 2003. The Government o f Tamil Nadu i s loolung to developments at the Govemment o f India level, both for detailed parameters and rules and institutional arrangements (recordkeeping, investment policy). But given the relatively slow state o f progress, it may be necessary to develop interim arrangements so that the new scheme can be implemented soon after the new entrants recruited since April 2003 will have passed through their probationary period and become eligible for: pensionable service. The implications and potential costs o f different options are being reviewed.

54. Rationalizing subsidies and improving targeting. Direct subsidies were the third fastest growing revenue expenditure, next to pension and interest expenditure. The largest subsidy went to food (of which the rice subsidy accounts for 90 percent) distributed through the public distribution system (PDS). Food subsidies accounted for 67 percent o f direct subsidies or 8.5 percent o f the state’s revenue in 2000/01. The PDS i s probably the most important safety ne t program in India. A survey conducted by the Public Affairs Center” shows that Tamil Nadu’s PDS ranks f i r s t in the country on several parameters, including access, usage, and reliability. Tamil Nadu’s PDS had universal coverage until 2002, with a l l 16 m i l l i on families in the state entitled to the PDS.

55. Substantive PDS reform was undertaken from 2002 to 2003, but the reform has suffered a setback. Rice procurement by the state through the Tamil Nadu Civ i l Supplies Corporation has been replaced by purchases from the Food Corporation o f India, saving milling and inventory costs and lowering the cost o f purchase. Production incentives given by the state over the minimum support price set by the Government o f India have been eliminated. About 4 mi l l ion out o f 16 m i l l i o n families have chosen to opt out o f PDS rice through a self-selection scheme. Rice coupons were then introduced to

’ The pension exercise i s the largest among the Ind ian states the Bank has been working with. The quali ty and speed of data collection are impressive. lo A well-known NGO in India.

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reduce the number o f households eligible for PDS r ice further to 10.4 mi l l ion. Income criteria to determine PDS eligibility-monthly household income o f Rs.5,000, income tax and sales tax assesses- was introduced in 2003 for voluntary compliance. But both rice coupons and income targeting have been withdrawn by the G o T N after the national election in April-May 2004. The PDS coverage i s l ikely to increase to 12 mi l l ion and the food subsidy bill to Rs. 930 crore in 2004/05, which i s below the maximum subsidy amount o f Rs.1,540 crore incurred in 2000101 but higher than the projected Rs. 768 crore in the M T F P .

56. Reforming public sector units and cooperatives. Impl ic i t subsidies and fiscal support to the public sector enterprises and cooperatives (through, for example, l o w user charges, interest subsidies, and loan write-offs) and guarantees to these entities have led to growing contingent liabilities. State transport units, with 120,000 employees and an accumulated loss o f Rs.2, 090 crore as o f March 2002 (Rs. 2,166 crore as o f March 31, 2004), accounted for about 70 percent o f employment and 73 percent o f accumulated losses o f all public sector units in 2001/02. The 18 cooperative spinning mills and 16 cooperative sugar mills, employing 20,000 people, dominate the financial losses incurred by the cooperative sector. There are also nine public Statutory Boards formed under independent legislative acts, spanning f rom electricity to maritime transport to pollution control. The TNEB, accounting for 80 percent o f employment o f the nine Statutory Boards, and dominates the balance sheets.

57. The state’s strategy for reforming the state transport units (STUs) comprises improving internal efficiency, downsizing the work force, adjusting the fare structure, and implementing partial privatization. Public transport bus fare was increased by 27 percent and annual bonus and ex gratia payments to STUs employees were cut f rom about 20 percent to the statutory minimum o f 8.33 percent. The crew-to-bus ratio has been reduced from 7.9 to 7.6. The STUs have been consolidated f rom 18 state transport units to 7 which i s expected to result in a saving o f 10 percent on overhead cost. As a result, the financial performance o f the state transport units has improved somewhat though not consistently. In 2002/03, the STUs incurred a loss o f Rs. 4 crore showing an improvement in Performance, but in 2003/04 there appears to have been a slide in performance with a pre-audit loss figure o f Rs. 32 crore. Further reform plans include: rationalizing the crew-to-bus ratio to reach a target level o f 6.5, and implementing a phased program o f privatizing 20 percent o f routes.

58. The Government announced a pol icy decision to exit al l manufacturing public sector undertakings (PSUs) and sick cooperative spinning and sugar mills, fo l lowing the Go1 framework and guidelines for VRS prior to closure and divestment. T o facilitate divestment, institutional mechanisms, the Cabinet Committee on Divestment and a high-powered Interdepartmental Committee o n Divestment have been established. A legislative amendment to the Tamil Nadu Cooperative Societies Act, enabling sale o f assets o f sick cooperatives, has also been passed by the state legislature. All cooperative spinnindsugar mills identified for closure are sick mills.

59. Eight public sector undertakings, eleven out o f eighteen cooperative spinning mills and two out o f sixteen cooperative sugar mills have been closed. The VRS has been accepted by 8,426 employees. The VRS has also been accepted by 2,554 employees in twelve more public sector undertakings enabling restructuring o f these entities. The Tamil Nadu Industrial Explosives L imi ted was chosen to be privatized f irst but progress has been slow. Counseling has been initiated for the retrenched employees.

60. The Tamil Nadu Electricity Board. The Tamil Nadu Electricity Board (TNEB), a state monopoly, i s relatively efficient in the Indian context. With the second largest power market in India, per capita consumption o f electricity in the state i s 567 lulowatts a year (national average o f 355 kilowatts). In 2001/02, 61 percent o f the electricity was sold o n a metered basis-much better than in other states (34 percent in Karnataka, 41 percent in Andhra, 39 percent in Gujarat, and 47 percent in Maharashtra). Technical and distribution losses are about 18 percent, much lower than those in many other Indian states.

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The TNEB has an active enforcement system to penalize power theft. Collection efficiency has been consistently high (about 98 percent).

61. Yet financial losses rose steadily f rom 1997/98 to 2001102. Earnings before interest, depreciation, tax, and amortizations (EBIDTA) turned negative in 199912000, reaching negative Rs. 1,225 crore in 2001102 (Figure 2.1). T h e distress i s attributed to increasing power purchases costs and increasing cross- subsidization. Sales to subsidized categories (residential, agriculture) grew rapidly while the subsidizing HT industrial sales remained stagnant with increasing dependence on self- generation. The state has a 2,475 megawatt captive generation capacity. From 1996197 to 2002/03, the proportion o f purchased power to total power input increased from 31 percent to 48 percent.

Figure 2.1 : TNEB’s Financial Performance Trend

loo0 1

0

2 e i (1°00’

Y

(3000) J

1 WEBIDTA OProfit before subsidy I

62. At the same time, the average cost o f purchases increased from Rs. 1 per hlowatt-hour to Rs.2.68 per kilowatt-hour, largely because o f high-cost Independent Power Producers (IPPs). The severe droughts in 2001 and 2002 depleted cheaper hydro resources, forcing their replacement with more expensive thermal power.

63. The financial distress constrains the TNEB’s ability to make investments, resulting in generation shortage and uneven quality o f supply. As in many other Indian states, long-term PPAs for contracting generation capacity have not worked wel l and have resulted in high IPP tariffs. In i t s recent tar i f f order, the Tamil Nadu Electricity Regulatory Commission directed the TNEB to explore options for reducing IPP tariffs to more reasonable levels.

64. A number o f init ial steps were undertaken from late 2001 to 2003. The Government made the Tamil Nadu Electricity Regulatory Commission functional in 2002. T w o tar i f f adjustments-a 16.5 percent increase in December 2001 and a 13.5 percent increase in March 2003 (latter by the Commission)-have helped to reduce cross-subsidies and improve the financial health o f the TNEB. All new agnculture consumers were metered from July 2002. The Government also brought onto i t s budget Rs. 1,962 crore o f the TNEB’s past dues to central power utilities to clean up the TNEB’s balance sheet.

65. Reducing agriculture cross subsidies in the power sector has proven to be extremely diff icult. If cross-subsidy issue i s not addressed, then either the state budget would have to bear an increasingly larger subsidy burden or the tar i f f o f subsidizing users (e.g., industrial and commercial users) would have to be increased. Increasing industrial power tariff, which i s already high, would force more industrial and commercial consumers to leave the state utility grid, putting further pressure o n the state uti l i ty’s finances. When implementing the agnculture tar i f f set by the regulator in March 2003, to reduce the negative impact o f the tar i f f on small and marginal farmers, the Government implemented a direct subsidy scheme for smallholders and marginal farmers (Rs.lOO crore) and hut dwellers (Rs.14 crore), a significant experiment toward a direct and transparent subsidy system. Even then the bulk o f the subsidy burden (about Rs. 3,500 crore) rested with the TNEiB. Agriculture metering and the introduction o f power sector tar i f f for agriculture became contentious polit ical issues in Tami l Nadu during the M a y 2004 national elections. Fol lowing the elections, G o T N followed Andhra Pradesh in announcing free power to farmers thus reversing the nascent reforms. The Government also reversed i t s earlier 30% increase in the tar i f f for domestic consumers. The experimental direct subsidy to farmers was given up in favor o f

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budget support to the TNEB for costs incurred towards free power to agriculture and hut dwellers (Rs. 114 crore) as well as subsidized power to domestic consumers.

66. The reversal in the tar i f f for domestic consumers will have a much larger immediate fiscal impact: o f about Rs. 720 crore. With tar i f f increase unlikely in the next few years, given recent events, overall losses could exceed the reformist business plan by Rs.923 crore in 2004105 to Rs. 2,034 in 2006/07 under a conservative scenario. Under more aggressive assumptions, losses could be higher by Rs. 1,200 crore in 2004105 climbing to Rs. 2,681 crore in 2006107. This o f course assumes there i s n o financing constraint. Budget support o f this order to finance TNEB’s resource gap will strain fiscal recovery. Financing TNEB’s resource gap through state guaranteed borrowing would increase G o T ” s contingent liabilities and financing costs o f TNEB besides the high opportunity cost that this involves in terms o f resource misallocation. In any situation the financial recovery o f TNEB i s unlikely to be sustained, investments are l ikely to be constrained, and finances and service quality are l ikely to deteriorate. Further, in both scenarios, the consolidated fiscal deficit wi l l be back at or above pre-reform levels, and productive spending will be crowded out by power subsidies.

67. The long-term financial sustainability o f the power sector in Tamil Nadu, as in other Indian states, will require the formulation and implementation o f a comprehensive reform program that addresses the requirements o f India’s new Electricity Ac t 2003-including competition in the power sector and metering a l l un-metered consumers. But detailed implementation arrangement o f the A c t remains unclear in key aspects.

68. Institutional reform of, and restructuring requirements for, Tamil Nadu’s power sector need to be developed and implemented in accordance with the provisions o f the National Electricity A c t and the specific needs o f the state. K e y aspects to be addressed include the generation cost, the abil ity to attract sustainable private investment, and human resource requirements.

69. The experience o f metering existing consumers in other states has generally been unsuccessful and will remain polit ically challenging in Tami l Nadu as well. A consensus i s emerging that introducing metering o f agriculture pump sets requires an integrated solution that incorporates water and power issues and demonstrates improved efficiency o f pump sets and better delivery o f paid-for services (power, irrigation, extension, post harvest marketing), resulting in higher farm incomes.

70. Improving public expenditure management. The Government o f Tamil Nadu has initiated reforms o f the systems and processes o f budget formulation and execution. Whi le the existing annual budget system i s functional, reforms are needed to achieve the Government’s development objectives and to adapt the institutional arrangements to support the fiscal strategy. The key challenge i s to ensure that a comprehensive resource framework and a medium-term perspective effectively guide the three objectives o f budget management: aggregate fiscal discipline in l ine with the medium-term fiscal program, strategic policy decisions by the Government within the constraints o f the fiscal program, and efficient use o f public expenditure in government operations. In each o f these areas, the Government o f Tami l Nadu has initiated or proposed major actions.

71. The Tamil Nadu Fiscal Responsibility A c t (FRA) lays the foundation for aggregate fiscal discipline by emphasizing transparency and disclosure o f the medium-term fiscal program with each budget. In addition to the required polit ical commitment to the fiscal adjustment, credible medium-term fiscal planning will require strengthened government capacity to project revenue over a multiyear period, and key indicators such as the fiscal deficit will have to be made consistent with standard international practice to be fiscally transparent and to facilitate monitoring o f fiscal trends. International experience suggests that fiscal responsibility legislation i s neither essential nor sufficient for fiscal adjustment, but that i t can be a useful institutional complement to fiscal pol icy reforms. Performance in the four other Indian states that have so far passed FRAs (Karnataka, Kerala, Punjab, and Uttar Pradesh) has been m ixed

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wi th different levels of ownership and commitment. More attention wil l be required both by government and by outside parties to comply w i th FRA provisions post-adoption.

72. To improve the strategic budgetary tradeoffs on pol icy initiatives, Tamil Nadu needs to substantially strengthen its upstream capacity for policy formulation. Government departments in Tamil Nadu prepare specific pol icy notes to set out government sectoral objectives and articulate how government expects to achieve i t s objectives through service delivery, financing, partnership, or regulation o f private activity (Box 2.3). Such policy notes, appropriately strengthened in process and content, could form the basis for linhng the government’s objectives in specific sectors with departmental budgetary preparation and financial requirements. This i s necessary to ensure that well-crafted departmental pol icy proposals, together with their financial implications, are submitted for cabinet review and discussion during budget formulation. The establishment o f a Policy Review Committee, to be chaired by the Development Commissioner, could provide leadership and focus to this key capacity- enhancing reform. The Policy Review Committee can rely on a network o f public and private institutions to undertake public pol icy research and analysis. An appropriately staffed cell o f the Planning and Development Department can be established to develop and maintain the network relationship with institutions.

73. Current processes for budget formulation in Tamil Nadu distinguish between existing expenditure commitments (Part I) and new expenditure commitments (Part 11)-mahng them extremely amenable to adaptation to improve cabinet decision-making on pol icy priorities within the medium-term fiscal program. The Standing Finance Committee o f Cabinet can be made responsible for reviewing new pol icy and project commitments under Part I1 o f the proposed budget and ensuring that priorities are funded within the agreed fiscal constraint. Current budget instructions require departments to submit multiyear budgets for both Part I and Part 11. In subsequent years, the budget documentation needs to be improved to provide a clearer link between pol icy priorities and goals, budget allocations and performance.

74. The operational efficiency o f government departments i s a function, among other things, o f the predictability o f budgetary resource flows, appropriate incentives and managerial discretion for department and project managers, and periodic evaluations o f the effectiveness o f government programs. An earlier submission o f the draft budget to the legislature can help br ing budget approval closer to the start o f the fiscal year, facilitating budget execution. A review o f budget execution processes can help identify and address current weaknesses. Together with improvements in internal control systems, the Government should explore an increase the scope for virement within departmental budgets. The Government should also plan to constitute a standing Expenditure Review Committee to oversee time- bound implementation o f expenditure rationalization recommendations o f the Staff and Expenditure Reform Commission and to undertake rol l ing annual reviews o f departments to identify unproductive programs and to rationalize and improve efficiency o f existing programs.

Box 23: Policy Note on Demand No. 41: School Education, 2003/04 The policy note begins with a clear statement o f objectives-encompassing inputs and outputs, with an explicit indication o f budget for 2003/04 o f Rs. 4,203.8 crore, of which Rs.3946 crore i s non-plan allocation and under Part 11, including vari and a listing o f recent acco issued for village libraries, counseling system for teacher transfers, etc.). The principal thrust o f the note, however, i s covered by specific chapters for each topic- elementary education, secondary and higher secondary education, teacher training, etc. Under elementary education-the policy note cites the Compulsory Education Act o f 1994195 and identifies objectives (full enrollment, retention until eighth standard, quality education for learning competence, micro-level decentralized planning, and community participation). T h e structure o f the policy note suggests an informational purpose rather than a document that seeks to make the case for a policy initiative or to justify a specific funding request. For the most part, i t reports agreed objectives and indicates programs that are under way to achieve stated objectives with occasional discussion of financing being supplemented by central programs (such as the Education for All program). Source: GoTN’s Budget Documents

allocation. I t identifies the “new schemes” enance items (repairs to office buildings, etc.)

(number o f vacant teacher positions filled, orders

I

75. Strengthening financial accountability. The framework for public financial accountability in Tamil Nadu i s generally sound. I t s strengths include the oversight role o f legislature over public finances, regular compilation and timely preparation o f monthly accounts and presentation o f annual financial statements (usually within six months after close o f accounts), and the constitutionally guaranteed independence and broad mandate o f the Comptroller & Auditor General. Nevertheless, several areas need strengthening and enforcing to make the public financial accountability system effective and to support the objectives o f the Government’s medium-term fiscal and governance reform program.

76. The need for reform i s particularly evident in the area o f budget execution procedures, including the weaknesses in internal controls and the need to eliminate or reduce reliance on Personal Deposit Accounts in the Public Accounts, which distort expenditure and the fiscal deficit. I t i s also necessary to modernize the existing computerized treasury systems with upgrading and networking, to improve the quality o f internal audits, and to have more effective legislative oversight and timely responses and follow-up to audit observations.

77. The Government o f Tamil Nadu has started classifying and reporting details o f guarantees in the budget document with a risk rating o f the guarantees. A committee headed by the Chief Secretary was formed to review and discuss the status o f responses to audit observations in biyearly meetings.

78. management, and has prioritized the following actions f rom the year 2004/05 onwards.

The Government o f Tamil Nadu has outlined an agenda for further strengthening financial

0 Budget execution. The Government intends to review budget execution procedures to identify systemic constraints to effective execution, and to define and implement appropriate remedies.

0 Internal control. The Government intends to address and strengthen certain basic financial management and internal controls that could affect the reliability o f fiscal and financial information, improve the overall internal control environment, and reduce the r i sk o f misuse o f public funds. Proposed actions include takmg stock o f and formulating rules for write back, opening, and validity o f the Personal Deposit Accounts in the Public Accounts. The Government also intends to develop measures to address key internal control issues such as reconciliation o f accounts, reconciliation o f loans and advances, t imely submission o f utilization certificates, and incentives for compliance.

0 Treasuiy Plans are to be drawn up and implemented to upgrade and network the computerized setup for the Treasury (including departments under the letter o f credit system), and develop a financial management information system for departments. The plan would also address the need for extending computerization to drawing and disbursement offices to enable computerized bill preparation, recording, and control over commitments.

0 Internal Audit. The Govemment o f Tamil Nadu would create a workmg group to review the scope, coverage, and focus o f existing internal audit function, with a v iew to moving toward a “risk-based” audit approach and to implementing the recommendations o f the working group o n a pi lot basis.

0 External uudit and legislative oversight. To make the proceedings o f the committee headed by the Chief Secretary more effective, a database o f a l l the audit observations would be prepared to monitor and improve the responsiveness to the audit observations. One senior official within the finance department would be responsible for maintaining the database and fol lowing up o n the audit responses.

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Initial Outcome of Fiscal Reform

79. This section reviews the init ial outcome o f the fiscal reform program. The projected adjustment path as prescribed by the MTFP i s summarized in the next section, along with the implications to the adjustment o f the recent reform reversals (para 3 1).

80. Revenue performance. Tamil Nadu already has one o f the highest own tax/GSDP ratios in India but the ratio had fallen to less than the level o f 10% achieved in the early 1990s. The Government made significant efforts to increase the tax-to-GSDP ratio f rom 8.8% in 2001102 to 9.4% in 2003104. Buoyancy in sales tax revenue was restored, with near 14.5% average growth in 2002/03 and 2003/04. The state's own annual incremental revenue almost trebled from Rs.538 crore in 2001102 to Rs.1,561 crore in 2002/03 and Rs. 1,603 crore in 2003/04.

8 1. Expenditure composition. The composition o f recurrent expenditure improved, with a significant narrowing o f the gap between revenue expenditure and revenue receipts. Mos t notably, salaries and pensions as share o f the state's own tax revenue was reduced from a peak o f 100% in 1999100 to 71% in 2003104, and as a share o f revenue expenditure, reduced from 56% to 45% over the same period. The food subsidy was reduced from a high o f Rs. 1,540 crore (7.3% o f revenue expenditure) in 2000101 to Rs.800 crore (3.2% o f revenue expenditure) in 2003104. Non-wage O&M as a share o f revenue expenditure declined from 9.3% in 1999/00 to 8% in 2001102, but rose back up t o 9.9% in 2003104. Tamil Nadu's outstanding small savings debt stock as o f March 3 1,2002, with interest rates above 13% was Rs.4,400 crore, or about 12% o f debt stock. Over 2002103 and 2003104, G o T N swapped Rs. 3,100 crore o f small savings debt under the Go1 debt swap scheme. The remaining small savings debt stock has been swapped in 2004/05. Annual interest savings wil l be over Rs. 200 crore. Consequently, interest expenditure has held steady at 20% o f revenue receipts in 2002103 and 2003/04. In addition, G o T N repaid about Rs. 700 crore to NABARD and about Rs. 500 crore in o f f budget borrowing in 2004105.

82. Budget deficit improves. The impact o f the fiscal adjustment program has been impressive. Whi le the revenue (current) deficit declined f rom 2.1% o f Gross State Domestic Product (GSDP) in 2000/01 to 0.9% o f GSDP in 2003104 and 2004/05(RE), the fiscal deficit declined f rom 4% o f GSDP to 2.4% o f GSDP in 2003104 but has r isen to 2.9% in 2004/05(RE). The state also achieved a primary surplus o f 0.3% o f GSDP in 2003/04 as compared to a deficit o f -2.5% o f GSDP in 1999100. But an attempt to boost capital outlay by almost 22% over budgeted estimates in 2004/05(RE) will turn the primary surplus o f 2003104 to a small deficit o f 0.3% in 2004/05(RE). It remains to be seen whether the state i s able to spend as much by the fiscal year end as the higher outlay i s unprecedented.

83. Consolidated fiscal deficit performance. A key objective o f fiscal adjustment was cleaning up o f accumulated arrears f rom prior years. A large amount o f arrears, Rs. 3,062 crore equaling to 2% o f GSDP, was cleared in 2002/03, including Rs.1,100 crore arrears f rom 2001/02, and the securitization o f Rs.1,962 crore o f dues to central electricity utilities by the Tamil Nadu Electricity Board. There are pension arrears o f Rs. 1,000 crore f rom 1999100 when the previous Government postponed these payments for five years due to a liquidity crisis. These arrears are included in the MTFP for clearance by paying Rs. 2,500 crore, Rs.300 crore and Rs.450 crore over three years f rom 2003/04 to 2005/06 although their actual clearance can take a l itt le longer.

84. Despite clearing up the arrears, the consolidated fiscal deficit was reduced from a peak o f 6.7% o f GSDP in 1999/00 to 4.8% in 2002103 (Table 2.1)." The close to two percentage point reduction f rom

The consolidated fiscal deficit o f 5.8% in 2000101 and 5.2% in 2001102 underestimated rea l levels owing to accumulation o f (non-pension) arrears: Rs.2, 345 crore (1.7% o f GSDP) in 2000101 and Rs. 3,062 crore (2% o f GSDP) in 2001102.

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1999/00 to 2002/03 was largely attributed to an increase in the ratio o f the state’s own tax revenue to GSDP (from 8.6% in 1999100 to 9.3% in 2002/03), and a reduction in the ratio o f salaries to GSDP (from 6.5% in 1999100 to 5.2% in 2002/03). Unfortunately, capital outlay and net lending suffered a reduction equaling to 0.4% o f GSDP (due largely to a lack o f financing and implementation capacity). The consolidated fiscal deficit i s estimated to have decreased to about 3.8% o f GSDP in 2003/04 based on estimates for TNEB as against the M T F P target o f 4.8% o f GSDP for the year.

Table 2.1: Primary, Revenue, Fiscal and Consolidated Deficits as a Percent of GSDP 1997198 1998/99 1999/00 2000/01 2001/02 2002/03 2003/04

Primary Deficit 0.6% 2.3% 2.5% 1.8% 1.1% 1.9% -0.3% Revenue Deficit 1.1% 2.6% 2.8% 2.1% 1.7% 3.0% 0.9% N o n Power Deficit (1) 1.4% 4.0% 5.1% 4.1% 3.2% 3.1% 2.2% Budgetary Support to Power (2) 0.9% 0.2% -0.4% -0.1% 0.2% 1.4% 0.2% Budgetary Fiscal Deficit ( l t 2 ) 2.3% 4.1% 4.6% 4.0% 3.5% 4.5% 2.4% Power Sector Financing Requirement (3) 0.8% 1.2% 1.6% 1.7% 2.0% 1.7% 1.4% Consolidated Fiscal Def ic i t (1+3) 2.2% 5.2% 6.7% 5.8% 5.2% 4.8% 3.8% Source: GoTNs Budget documents and TNEB’s accounts Note: Deficits in 2000/01 and 2001102 were lower due to accumulation ofarrears. Data for 2002103 includes clearance of arrears equal to 2% ofGSDP. Pension arrears in 1999100 are included for clearance in 2003104,2004105 and 2005106, respectively.

85. The financial performance o f the Tamil Nadu Electricity Board improved during the period 2001102 to 2003/04. TNEB’s EBIDTA i s estimated to have decreased from negative Rs. 1,207 crore in 2001/02 to negative Rs.537 crore in 2002/03. The net loss before subsidy i s estimated to have been reduced from Rs. 1,854 crore to Rs. 1,253 crore over the same period. The financial performance o f the state transport units (STUs) also improved, with net loss reduced by 98.6% between 1999/00 and 2002/03.12 But failure to revise transport fares since December 2001 has meant that the momentum o f improvement in financial performance has been lost. Consequently, the STUs net loss increased from Rs. 4 crore at the end o f 2002/03 to Rs. 32 crore at the end o f 2003/04(pre-audit).

86. Guarantees outstanding were 6% o f GSDP in 2003/04, below the ceiling o f 10% o f GSDP (un- weighted guarantees) set by the Fiscal Responsibility Ac t (also lower than, for example, Andhra Pradesh at 10%). The Government for the f i r s t time classified guarantees under five risk categories (from very high risk to nil risk) as per the guidelines issued by the Reserve Bank o f India, and made the information public via the 2003/04 budget. The risk-weighted guarantees (Rs. 3,362 crore) amounted to about 2% o f GSDP in 2003/04.13 A guarantee redemption fund along the lines recommended by the Reserve Bank o f India has been established. The Govemment also intends to institutionalize the process o f evaluating requests for guarantees.

87. The G o T N signed up to the Fiscal Reforms Facil ity o f Government o f India in 2003. As per the Memorandum o f Understanding, G o T N was required to achieve a Revenue Def ic i t to Revenue Receipts target o f 17.4% in 2003104. G o T N instead has achieved a major improvement over the target by achieving a ratio o f 6.5%. The Twel f th Finance Commission (TFC) has futed Tamil Nadu’s share in the total divisible pool o f central taxes at 5.305% as opposed to the prevailing 5.385%, a marginal decrease. But states’ share in the centre’s divisible tax pool has been increased from 29.5% to 30.5%, keeping the effective share o f Tamil Nadu unchanged at 1.6% o f central taxes during 2005/06-2009/10. The total

l 2 The finances o f the state transport units have not been incorporated in to the consolidated fiscal deficit. The Bank’s work o n states‘ fiscal reform has focused so far o n incorporating the finances o f the power sector in to the consolidated fiscal deficit. l3 The r i s k weights used are as follows: 100% risk weight assigned to the very h igh risk category, 75% to the high risk category, 50% to the medium risk category, and 25% to the l o w risk category. The nil r isk category used by the govemment i s treated as off-budget borrowing.

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devolution o f central taxes to Tamil Nadu over the five year period i s estimated by the TFC at Rs. 32,553 crore. T h e TFC has done away with normal central loan assistance for state plans in favor o f market borrowings. Tami l Nadu i s not affected by this change. The TFC has also recommended debt r e l i e f to the states in the form o f restructuring o f all central loans with state governments’ as o f March 3 1, 2004 outstanding as o f March 31St, 2005. The loans will be consolidated and rescheduled at 7.5% interest rate repayable over twenty years. This has been made conditional on states’ enacting Fiscal Responsibility Legislation, which Tamil Nadu government has already enacted malung i t eligible straightway. As a result, Rs. 6,872 crore o f outstanding central loans on Tamil Nadu government’s books wil l be restructured. The interest gain i s estimated at Rs. 1,195 crore in Tamil Nadu’s case over the period 2005/10. The TFC has also recommended debt write-off l inked to reduction in the revenue deficit o f the state government. Under the scheme, a certain proportion o f repayment o f rescheduled debt wi l l be written o f f by Government o f India over the period 2005106 to 2009/10. The quantum o f write-off i s l inked to the absolute amount o f reduction in the revenue deficit each year with the ultimate objective o f eliminating the revenue deficit by 2008/09. Tamil Nadu can benefit to the extent o f Rs. 1,718 crore in debt write-offs under the scheme. Tamil Nadu also gets Rs. 1,214 crore in grants for maintenance o f roads and bridges, Rs. 242 crore for maintenance o f public buildings, Rs. 30 crore for forests, Rs. 40 crore for Heritage conservation, Rs. 250 crore for development o f urban areas and Rs. 50 crore for sea erosion over 2005/06 to 2009/10.

88. GoTN’s MTFP has been revised along with the 2005/06 budget and accelerates the fiscal adjustment path when compared to the f irst MTFP. The revised MTFP builds in the TFC’s award conservatively as opposed to the actual award thereby providing a revenue cushion. The state benefits from TFC’s debt restructuring and debt write-offs while i t i s not affected by the abolition o f central lending in support o f state plans. However, to take advantage o f the debt write-off the state has to stay on track to eliminate the revenue deficit by 2008/09 which i s also the state’s revised MTFP target. If the G o T N maintains i t s current rate o f progress, it i s wel l poised to take full advantage o f the TFC’s recommendations. The costs o f policy reversals o f 2003/04 have thus been absorbed in 2005/06 but pose an underlying medium term fiscal threat unless effectively addressed.

Medium-Term Adjustment Path

89. Consolidated fiscal deficit. The medium-term adjustment path under the f i r s t MTFP (2003104- 2008/09), which was tabled in the state legislature on February 11, 2004, was predicated o n maintaining an increasing own revenue effort progressing f rom 10.2% o f GSDP in 2002/03 to 10.4% in 2008/09- with the state’s own tax revenue improving f rom 9.3% o f GSDP in 2002/03 to 9.8% in 2008/09-and further reorienting expenditure f rom salaries, pensions, and subsidies to non-wage O&M and capital investments, while stabilizing the consolidated fiscal deficit (see Table 2.2 below) to achieve a targeted real GSDP growth rate o f 6% by 2008/09.14

90. The reversal o f some reforms-PDS, bus travel concessions and electricity tar i f f after national elections in M a y have resulted in mid year expenditure o f Rs. 1,000 crore. Additional expenditure o f Rs. 650 crore was provided for in supplementary budgets increasing expenditure in 2004/05 to about Rs. 1,650 crore over the budgeted estimates (about 5% o f projected expenditure in 2004105). But lower expenditure under salaries and pensions o f Rs. 1,500 crore in the 2004/05(RE) as compared to the budget

l4 The MTFP was drawn up by the Government using 2003104 (revised estimates) as the base. Subsequently, higher Go1 devolution in March 2004 and savings under salaries and pensions and lower capital outlay resulted in the state exceeding the M T F P projections for 2003104. With revised estimates for 2004/05 available to government and taking into account the impact o f po l icy changes, the TNEB’s accounts for 2003104 and 2004105, the salary cost o f 15,500 new hires, the Twelfth Finance Commission’s award, revised GSDP growth projections etc. the first M T F P has been updated along with the budget for fiscal 2005106. However, it i s useful t o l ook in detail at the f i r s t MTFP as this was the state’s f i rst effort at fiscal projections and formed the basis for budget 2004105.

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estimates and stronger than projected revenue growth has meant that the fiscal deficit in 2004/05(RE) i s projected to be lower at Rs. 5,447 crore (3% o f GSDP) as compared to the budgeted Rs. 6,921 crore (3.8% o f GSDP). The lower fiscal deficit also builds in higher capital outlay and non wage operations and maintenance expenditure o f Rs. 1,100 crore as compared to the budget.15 As it stands, the increase in subsidy expenditure implies litt le threat to achieving the M T F P targets in the near term. But an opportunity i s being lost o f trying to correct resource misallocation and thereby decreasing underlying fiscal r isks on the expenditure side.

Table 2.2: Primary, Revenue, Fiscal and Consolidated Deficits as a Percent of GSDP Projected Under Tamil Nadu’s MTFP (February, 2004)

2002/03 2003/04* 2004/05 2005/06 2006/07 2007/08 2008/09 Primary Deficit 1.9% 1.3% 0.8% 0.3% -0.3% -0.5% -0.9% Revenue Defici t 3.0% 2.2% 1.9% 1.5% 0.7% 0.4% 0.0% Non Power Deficit (1) 3.1% 3.8% 3.6% 3.2% 2.6% 2.4% 2.1%

Budgetary Fiscal Deficit (1+2) 4.5% 4.1% 3.7% 3.3% 2.8% 2.5% 2.1% Budgetary Support to Power (2) 1.4% 0.3% 0.1% 0.1% 0.1% 0.1% 0.1%

Power Sector Financing Requirement (3) 1.7% 1 .O% 0.8% 0.6% 0.4% 0.1% 0.0% Consolidated Fiscal Deficit (1+3) 4.8% 4.8% 4.4% 3.8% 3.0% 2.5% 2.1% Source: GoTNs MTFP, Budget Speech 2004105. Note: Data for 2002103 are actuals, including clearance o f arrears equal to 2% o f GSDP. * 2003104 actuals have improved dramatically over the MTFP target Deficits for 2003104,2004105, and 2005106 include clearance o f pension arrears from 1999100.

91. Revenue performance. The ratio o f revenue to GSDP was projected to increase f rom 13.3% in 2002/03 to 13.7% by 2007/08 in the f i rs t MTFP. The scope for increase in the tax ratio i s constrained: by the already high tax effort in Tamil Nadu; the Constitutional restriction on state taxes to certain types and activities (particularly the state’s inability in taxing the bulk o f the fast growing services sector), the secular decline in Tamil Nadu’s share in shared taxes devolved by the central government, the relatively slower GSDP growth in Tamil Nadu in recent times and the perceived polit ical diff iculty o f substantial increases in user charges.

92. Expenditure composition. The share o f non-wage O&M and capital outlays and net lending to GSDP i s projected to rise f rom 2.9% in 2002/03 to 3.6% in 2008/09 in the f i r s t MTFP, owing largely to the projected decline in the share o f salaries (from 5.2% o f GSDP to 4.3%) and food subsidies (from 0.8% o f GSDP to 0.3%) over the same period. However, reversal in policy reforms pertaining to subsidies (para.3 1) may make expenditure adjustment relatively slow. I t i s not certain n o w whether the G o T N can undertake higher non-wage O&M and capital outlay without raising the fiscal deficit given the fiscal cost o f the new pol icy choices. The decline in the share o f salaries i s to come f rom a combination o f two factors: the net attrition o f 2.8% per year during the M T F P period (which are explained by the projected retirement patterns and hiring freeze) and the slower growth in the cost o f living indexation o f wages (i.e., dearness allowances).

93. Priority development expenditure. The first MTFP projected an increase in development expenditure (capital outlays and non-wage O&M) in priority infrastructure and social sectors (roads, rural water supply and sanitation, irrigation, elementary education (ages 6-14), nutrit ion and health). However,

l5 Four broad sets o f factors have additionally helped the state meet the challenge o f the additional expenditure: (i) salaries and pensions have remained virtually f lat in nominal terms in 2002103 and 2003104 (ii) the government expects conservatively to realize Rs. 1,500 crore o f savings under salaries and pensions expenditure as compared to the budget in 2004105, (iii) interest expenditure savings consequent to debt restructuring in 2004105 and (iv) revenues have been growing well during the fiscal year 2004105 exceeding the Budget projections ( 15% over 2003104 as opposed to annual 3% in the MTFP).

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the fiscal costs o f the policy reversals would shrink the resource space originally envisioned in the M T F P to make the desired expenditure adjustment.

94. Since about 80% o f total expenditure i s inflexible in nature (salaries, pensions, interest, subsidies and transfers), reform will have to target these heads o f expenditure if resources are to be found for non- wage O & M and capital outlay without expanding the fiscal deficit. The long-term economic growth consequences o f poor expenditure composition can be costly. The ability to increase social expenditure in critical areas such as education, health, water supply and sanitation, and nutrition may be affected. T o put the Rs. 1,100 crore expenditure on annual power subsidy in perspective: the state spends about Rs. 1,400 crore only (4% o f total expenditure) on the entire health sector and Rs. 750 crore (3% o f total expenditure) o n water supply and sanitation. The higher subsidy burden therefore represents a lost opportunity to improve social outcomes.

95. Pension reform (para 52) has slowed growth o f pension liabilities-reducing the implicit pension debt by 7% o f GSDP. However, it i s not realistic to expect reduction in pension expenditure in the short to medium term. This i s mainly due to the long-term nature o f pension policies, the acquired rights o f existing employees, the aging c iv i l service which, measured by per hundred population, i s larger than a l l other Indian states except Punjab, and the need for the Government to contribute to the new defined contribution scheme.

96. Revised MTFP. The MTFP has been revised to reflect changes in policy, TFC’s award, changes in underlying economic growth scenario and builds o n the 2004/05(RE). The revenue growth assumptions are conservative. For instance in 2005106, tax devolution to the state f rom the centre has been budgeted by the centre at Rs. 5,041 crore as compared to Rs. 4,407 crore in the f i rs t MTFP, a gain o f Rs. 634 crore if realized. The G o T N in i t s 2005106 budget has gone along with a more conservative assumption o f Rs. 4,672 crore, thus providing an inbuilt revenue cushion. The buoyancy o f Sales tax i s assumed at 1.05 from 2006107 onwards; state excise growth at 3.5% per annum, vehicles tax at 8% per annum and stamp duty at 5% per annum. The revised nominal GSDP growth assumptions although higher than the f i rst MTFP i s s t i l l an annual average 10.4 %. The revised M T F P targets revenue surplus in 2008109 as against a marginal revenue deficit in the f i rs t MTFP. The fiscal deficit i s to be reduced to 3% o f GSDP by 2005/06 as against the TFC’s requirement o f doing so by 2008/09. The revised fiscal targets are shown in Table 2.3.

Table 2.3: Primary, Revenue, Fiscal and Consolidated Deficit as a Percent of GSDP Under Tamil Nadu’s revised MTFP (March, 2005 )

2003/04* 2004/05(RE) 2005/06(BE) 2006/07 2007/08 2008/09 Primary Def ic i t 0.3 -0.3 -0.5 -0.2 0.1 0.4 Revenue Deficit -0.9 -0.9 -0.7 -0.6 -0.3 0 .o Fiscal Defici t -2.4 -2.9 -3.0 -2.6 -2.2 -1.9 Consolidated Fiscal Deficit -3.8 -3.9 -4.2 -3.5 -2.7 -2.3 Source: GoTNs MTFP, Budget Speech 2005/06. * Accounts, positive s ign indicates surplus

Fiscal Sustainability and Risks

97. If the fiscal reform and MTFP are broadly on track, Tamil Nadu’s debt stock i s expected to stabilize around 3 1% of GSDP in 2005/06, a level below that in many other Indian states. However, due to fiscal cost of recent policy reversals, the debt to GSDP ratio may increase f rom 31% o f GSDP in 2004105 to 32.3% o f GSDP by 2008109.

98. Tamil Nadu’s long-term fiscal sustainability will depend critically o n two factors: The f i r s t i s the evolution o f key national macroeconomic variables-real interest rates on government borrowing,

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inflation rate, and actual devolution o f the center’s shared taxes. The second factor consists o f the evolution o f two key variables-the state’s economic growth and the primary deficit-that will depend largely on the policies and reforms o f the state government. The central government can s t i l l influence these two key variables through for example: tax devolution policy, the Pay Commission, and policies o f a concurrent nature affecting economic growth (e.g., labor market reform and bankruptcy procedures). T o stabilize the debt-to-GSDP ratio over the long term, the government will need to implement reform measures that stimulate economic growth, eliminate primary deficit, or lower the effective interest cost o f borrowing-ar all.

99. These risks are:

There are significant r isks to fiscal adjustment across Indian states; Tamil Nadu i s n o exception.

Political resistance to adjustment. Correction o f the distortions and fiscal excesses o f several decades entails large short-term costs. These affect many vested interests and are often met with strong resistance. The resistance typically intensifies near and during elections. Prior to the national elections in April-May 2004, the polit ical leadership had provided strong support for reform. However, after the electoral loss some critical reforms were rol led back.

A key challenge in fiscal adjustment i s the perceived political diff iculty o f increasing user charges. This i s amply illustrated by the diff iculty o f pricing power supply to agnculture. Providing increasing budgetary support to would derail fiscal recovery. Financing the deficit through arrears or guaranteed-backed borrowing would increase the government’s contingent liabilities.

Unexpected macroeconomic shocks could threaten Tamil Nadu’s fiscal sustainability. India’s large fiscal imbalances could pose a threat to sustained economic growth. Slower growth and high fiscal deficits may translate into higher borrowing requirements but also put pressure on interest rates on government borrowing. This would negatively affect the ongoing debt restructuring efforts at the state level, hence the trajectory o f debt sustainability. Since interest and real growth rates tend to be negatively correlated, i t i s very l ikely that if interest rates start rising, economic growth wi l l decline, resulting in a rise in the debt-to-GSDP ratio unless fiscal pol icy i s adjusted. For instance debt dynamics modeling, the combination o f rising nominal interest rates (say between 11% and 14%) and economic slowdown (to 3%) imply that the government wi l l have to run surpluses in the range o f 0.9-1.9% o f GSDP in order to avoid increasing the debt-to-GSDP ratio beyond 35%.16

0 A decline in central government revenue transfer poses another risk. Successive federal Finance Commissions have reduced the percentage share o f Tamil Nadu in the pool o f net shareable central taxes, and the contribution o f the share o f central taxes to Tami l Nadu’s revenue declined from 21% in 1992/93 to 15% in 2002/03. The TFC’s award will be a determinant o f the pace o f fiscal adjustment at the state level. Central transfers to states (both as share o f revenue and GDP) have fallen over time because o f decrease in the revenue to GDP ratio o f the Go1 (Box 2.4). Further tax sharing i s necessary to reduce vertical imbalances between expenditure responsibilities o f states and their revenue powers and to address the revenue concerns o f relatively better-off states. For example, the Go1 can assign the right to states to tax a larger share o f services and raise the constitutional ceiling o n the professional tax. If and when the central government reduces or abolishes the Central Sales Tax, Tamil Nadu, as an exporting state, will lose tax revenue, and i t i s important that i t have other sources available to i t as compensation.

Details o f the model are presented in the report Tami l Nadu: Fiscal Reform and Sustainability, W o r l d Bank 16

(2004).

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Moreover, introduction o f VAT (announced for April 1, 2005) should be on the basis o f floor rather than harmonized rates, so that states l ike Tamil Nadu do not lose revenue as a result. Any shortfall in revenue due to VAT introduction could jeopardize Tamil Nadu' s medium-term fiscal

Box 2.4: Central Transfers to States have fallen

As Figure 2.2 shows, central transfers have fallen over the last two decades largely because Go1 revenue has fallen as a percentage o f GDP, and to a lesser extent because there has been a decline in grants to the states as a percentage o f central (gross) revenue. In the last few years, stronger revenue growth, and an increased share going to the states have helped reverse the long-term decline in Go1 transfers to states. However, transfers are yet to reach the 5% o f GDP level last seen in the early nineties.

F igu re 2.2: Trends in Go1 revenues and transfers to states 55.0%

a 50.0% g 52.5%

I 47.5%

e 45.0% 42.5%

0 40.0% C

37.5% $' 35.0%

3

f Transfers f r o m Go1 t o states (LHS) €

15% 14% 13% 12% g 11% 2 10% : 9% 5 8% 1 7 % 6%

Source: State Fiscal Reforms in India, Wor ld Bank (2004)

100. Extemal shocks are a major source o f risk to fiscal adjustment. Tamil Nadu's agriculture i s vulnerable to periodic droughts due to i t s dependency on rainfall. More frequent than in the recent past, three annual droughts including the unprecedented century's worst statewide drought in 2002, led to an annual average o f -3.9% growth during 1999100-2002/03 compared with an annual average o f 4.5% in the previous nine years. The droughts have greatly contributed to the slowdown in economic growth as wel l as the financial deterioration o f the power sector in 2001 and the slower recovery in 2002, notwithstanding tar i f f adjustments. Droughtts) during the medium-term adjustment period could seriously affect economic growth (and hence tax collection) and the TNEB.

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111. IMPROVING INVESTMENT CLIMATE FOR MANUFACTURING AND SERVICES

101. Fiscal reform must be complemented with a strong program to improve investment climate for accelerating economic growth and meeting the poverty reduction objective. The slowdown in economic growth in Tamil Nadu since the late 1990s and the structural impediments to faster economic growth would affect the pace of poverty reduction. The debt dynamics analysis underscores the importance o f accelerating economic growth to achieve fiscal correction and sustainability. Faster economic growth positively influences not only debt sustainability but also employment and income generation, facilitating a larger distribution o f reform gains.

102. Economic growth i s a key driver for sustaining and accelerating the pace o f poverty reduction and the attainment o f MDGs. Accelerating economic growth i s the foundation stone o f anti-poverty policies worldwide. A dynamic economy, growing strongly, i s a powerful force for creating new and better employment opportunities for poor people, enabling empowerment, and reducing vulnerability. Mos t o f the reduction in poverty in the recent period in India has been a result o f the increase in average consumption driven by economic growth (Deaton and Dreze, 2002). In India, policies that foster overall economic growth has the greatest potential for reducing poverty further (Ferro, Stern, et. al, 2003).

103. Cross-country evidence has demonstrated a strong link between investment climate and growth. There could be considerable growth gains f rom improvement in investment climate in Tamil Nadu. Investment climate influences the expected returns and f low o f foreign and domestic investment to a country or a location. In addition to macroeconomic policy, polit ical stability and national pol icy towards foreign trade and investment, investment climate comprises o f two critical factors: efficacy and transparency o f regulatory framework for factor markets (labor, capital and land), for taxation pol icy and administration as wel l as for starting or exiting a business; and quality and quantity o f available physical and financial infrastructure. Findings from the investment climate surveys in Tamil Nadu suggest that cumbersome and excessive regulation and infrastructure bottlenecks are major or serious constraints to growth.17 Accelerating economic growth wi l l require sound policy, institutions and infrastructure development to support private sector development.

104. Priority reforms concern labor market flexibility, a more responsive urban land supply system, more efficient tax pol icy and administration, streamlining regulations over entry, exit and operation, power sector reform and scaling up PPP for sustainable infrastructure development. Several important issues are exclusively or largely within the purview o f the central government: labor reforms, the introduction o f VAT, exit policy and b a n h p t c y procedures, and key infrastructure such as national highways, international air markets, major ports and rails systems. Within the federal framework, Tamil Nadu can explore reform opportunities.

Removing Regulatory Burdens

105. The regulatory framework i s broadly understood to include the following three areas: factor market regulations, i.e., regulations of labor, capital, and land markets; tax and customs administration;

l7 41% o f respondents in a W o r l d BanWCII survey identif ied infrastructure as a severe bottleneck to improv ing the investment climate as compared to say 25% in Gujarat. 47% f e l t power was a severe bottleneck, 43% felt transport was a bottleneck (second highest after Karnataka’s 50%). Senior management in the survey reported spending 13% o f their t ime dealing with regulations as opposed to say Haryana 10%.Tamil Nadu’s manufacturing establishments reported an average o f 11 off icial inspections a year as compared to 5 in Maharashtra and 6 in Karnataka. 14% o f respondents (second highest after Gujarat’s 2 1 %) in Tami l N a d u felt constrained by overstaffing. 42% respondents reported corruption as a growth bottleneck better than Kamataka’s 65% but worse than Andhra Pradesh’s 10%. Source: India Investment Climate Assessment , Wor ld Bank November 2004.

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and regulations o f entry, exit and operation through regulation requirements and bankruptcy laws. Tamil Nadu has made reform efforts to improve the regulatory environment for the private sector such as the entry regulation for larger investment projects and regulation and streamlining regulations over compliance with labor regulations, but the regulatory environment generally continues to be complex. Many o f the issues such as labor regulations, indirect tax, exit and bankruptcy procedures are largely within the purview o f the central government.

106. Labor market rigidity. Labor market restriction o n hiring and retrenching workers i s one o f the greatest challenges of doing business in India, according to the Global Competitiveness Report-India ranks 73rd o f 75 countries. Rigid labor regulations have prevented Tamil Nadu f rom unleashing i t s full potential in labor productivity. Tamil Nadu i s known for i t s good industrial relations and i t s highly educated, hard working and a disciplined labor force.

107. There are three main issues with labor legislations. The national Contract Labor Ac t 1970 restricts the hiring of contract labor. Any firm employing more than 100 employees must seek official permission for retrenchment or closure based on the national Industrial Disputes A c t o f 1947. The regulatory maze i s complex, leading to high compliance cost and rent-seeking. There are 23 Union Acts and seven State Acts and Rules which are enforced by the Labor Department in Tami l Nadu. For each o f these subjects there are different enactments by the center as well as implementing rules by the state. Many regulations are excessive and outdated (e.g., n o overlapping o f shifts, capping o f overtime, official permission required for worlung on Sunday or holidays, specified number o f food cafeterias, and over 60 types o f minimum wages).

108. Rigid labor regulations deter greater employment generation. Stringent labor institutions tend to benefit a narrow segment o f the population comprising the organized and unionized labor, intermediaries in the labor market, and corrupt officials, at the expense o f a much larger segment o f the labor force comprising the unemployed, those employed in the unorganized sector, andor agncultural laborers who are seelung jobs in the organized industrial sector.

109. Labor regulations are largely within the purview o f the central government. Nonetheless, within the federal framework, Tamil Nadu can explore ways to rationalize and consolidate implementing rules concerning the legal framework governing labor and statutory compliance requirements to create elbow room for contractual labor relationship and for easing threshold for retrenchment. The experience o f Maharashtra and Andhra Pradesh in attempting a more flexible interpretation o f the central regulations may be o f relevance to Tamil Nadu.

1 10. Constraints in finance. The issues o f access to and cost o f finance are at the purview o f the central government, thus affecting a l l states. The key obstacles are high interest costs, collateral requirements, and burdensome paperwork. Recent downward trend in interest rates has been a factor responsible for revival o f industrial growth. India's Small and Medium Enterprises (SME) sector s t i l l faces a relatively high cost o f capital, owing to market and policy government failures. There i s an adverse selection in the credit appraisal process for SMEs, and interest rate premium for the higher transactions costs in dealing with small borrowers, the lack o f sufficient credit information on these f i rms, their frequent inabil ity to provide collateral, problems in collecting o n collateral (typically landproperty) f rom small borrowers due to the lack o f updated landproperty records and the uncertainty surrounding land ownership, resulting in higher costs o f default and contract enforcement.

11 1. Urban land market constraints. Urban land markets play a critical role in urban infrastructure. They provide the physical space for industrial, commercial and residential development as we l l as providing rights o f ways for critical infrastructure systems such as roads, transit, water and sanitation and power networks. Significant and growing demand for urban land requires an efficient land delivery system, effective land zoning and a regulatory process for infrastructure and housing development review

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and permission. Rapid urbanization and demographic growth-from 19 mi l l ion urban population to 27 mi l l ion in the 1990s in Tamil Nadu-generate significant demands for urban land (Table 3.1). In order for cities to grow, either agncultural land at the periphery or vacant and underutilized land in urban areas must be developed.

Table 3.1 : Prqjected urban population and employment growth in three cities

Annual Annual Projected Annual Projected Projected Annual Urban Land Industrial Land

Metropolitan Population Employment Requirements Requirements Area (LPA) growth growth hectares hectares Chennai 1991-2011 180,000 24,400 1,900 250 Coimbatore (1991-2001) 46,000 17,600 600 160 Tirupur

Note: Data from the master plans o f the three cities. (2001-2021) 16,800 17,000 420 200

112. The init ial assessment found the following systemic weaknesses in urban land market in Tamil Nadu: Master plan designations in the absence o f complementary incentives and measures make the supply o f land for development inefficient; land acquisition and project development i s complex, time consuming and expensive; obtaining permission and license for building construction industry i s complex and time consuming; f loor space Indices (FSI) are overly restrictive; over-designed subdivision regulations exacerbate the effects o f l o w FSI; rent control, though not enforced for a l l buildings, also limits supply by discouraging owners f rom redeveloping properties to more intensive uses; taxes on land transfers are high comparing with international practices; and considerable land across cities i s held by government agencies immobilized. These systemic weaknesses have led to more expensive facilities and housing than necessary, promoting urban sprawl, and led to 1.3% lost GDP per year for India.

113. Urban land issues are within the purview o f the state govemment. It i s important to rationalize regulations on urban land zoning and development controls, and project approval and land acquisition processes, and develop a more effective planning and management system to facilitate infrastructure development. As a f i r s t step to prepare for reforms, the Government o f Tami l Nadu i s undertalung a comprehensive urban land audit in Chennai, in collaboration with the private sector and an academic institution and planned to extend the audit to secondary cities.

114. Constraints in the sales tax system. Whi le the Tamil Nadu sales tax system generally i s buoyant and the state has one o f the highest o w n tax effort, i t has a number o f features which have a negative impact o n the investment climate and long-term growth. The existing sales tax regime, the main source o f Tamil Nadu’s own revenues, i s inefficient with multiple rates, non-standard classification o f goods, and concentration o f taxation on certain sectors. It has a relatively high tax burden o n inputs, with the effective tax rate on inputs at 6.7% and taxation on inputs accounting far 32% o f the total collection. Figure 3.1 depicts effective tax rates in 2002/03 for select commodities. The complex structure induces high compliance costs, while the frequent ad-hoc changes in the tax regime generate uncertainty for businesses.

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120. An important entry deterrent has been the Small-scale Industry Reservation (SSIR) policy by the central govemment. This policy discourages economies o f scale and greater efficiencies-by inhibiting small f i r m s f rom investing beyond the stipulated limits, expanding their operations in the domestic market, and then moving into exports. Although some o f the important i tems have been de-reserved (e.g., garments, toys and leather products), SSIR has had significant negative impact over decades on the competitiveness o f Indian industries.

121. Despite the remaining influence o f the SSIR, Tamil Nadu can further streamline entry regulations in two areas: streamlining regulations concerning construction and real estate industries and extending the simplified entry regulation covering large investment projects to smaller projects in every level o f investment.

122. Exit and bankruptcy procedures, both at the purview o f the central govemment, remain outdated and ineffective, leading to inefficiencies and malung industrial restructuring almost impossible. The Amendments to the Companies A c t (2002) should improve the bankruptcy framework. The effectiveness of the amendment will depend on the repealing o f the Sick Industries Companies Ac t and the pace o f labor market reform.

Resolving Infrastructure Bottlenecks

123. Infrastructure i s more developed in Tamil Nadu than in many Indian states but compares poorly with other emerging economies. Close to 40% o f surveyed managers and about 50% o f exporters in Tamil Nadu view infrastructure as a major impediment to investments and growth. The infrastructure constraints are across-the-board including power, transport, ports and water. Substantial investment requirements also arise f rom rapid urbanization in Tamil Nadu. B o x 3.1 reflects the Wor ld Bank’s own interaction with entrepreneurs in Tirupur, India’s leading hosiery exporting centre.

124. Power has become a top infrastructure constraint despite the relative efficiency o f the state power utility and having the second largest power market in India. High power tar i f f to industries and poor quantity and quality o f power supply reduce the competitiveness o f Tami l Nadu’s industries. The financial stress o f the TNEB, arising largely f rom cross subsidy to agriculture (and n o w the domestic consumer segment also), has increasingly constrained i t s investment abil ity to improve the quality o f power supply. Captive generation sets in operation as a share o f total electricity sold in Tami l Nadu has reached 15%, with a statewide average captive plant load factor o f 25%. The capital cost o f captive generation sets constitutes about 11% o f total f ixed assets for small businesses. L i ke many other states, Tamil Nadu will need to find a polit ical solution to the metering o f agriculture pump sets and reduction o f cross-subsidy to improve the competitiveness o f industry and services.

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125. On transport, India has n o access-controlled expressways linkmg the major economic centers, while for example China has built substantial expressway capacity (over 27,000 kilometers) since the mid-1990s. Poor riding quality and congestion result in truck and bus speeds on Indian highways that average 30-40 kilometers an hour, about hal f the expected average. Demand for road transport has been

Box 3.1 : Infrastructure Bottlenecks Facing TEKIC in Tirupur The Tirupur Export Knitwear Industrial Complex (TEKIC) i s one o f the major industrial estates or clusters in Tirupur. Tirupur has a population o f about 420,000, but exports US$1 billion in knitwear, accounting for about 18% o f total Indian knitwear exports in 2000101.

TEKIC h a s 189 laid out sheds situated in and around 100 acres o f land and 148 industrial uni ts with small and medium investment in operation. Most firms in the complex export to U S and Europe markets. In the last three years, member firms have exported about Rs.1750 crore of knitwear (close to US$400 million). The complex employs about 10,000 workers. A World Bank team met with a dozen representatives o f businesses in the complex in May 2003. The following infrastructure constraints were highlighted by the representatives:

Power cuts and fluctuation make it difficult to use precision machinery and equipment which are essential for export products;

Road congestions around the complex, in Tirupur and to the ports.

Adding to these are the rigid labor regulations which make it difficult to efficiently adjust workforce to meet seasonal variations in business demand, while such variations are typical in garment exports.

TEKIC faces huge competitive pressure with the phasing out o f quota-based export system under the Multi- Fiber Agreement. Infrastructure investments are thus urgently needed to make it possible for TEKIC to prepare for competition.

The urgently required infrastructure requirements according to the entrepreneurs are:

Setting up a power plant to provide reliable quality power supply. Strengthening and widening the existing road and providing storm water drain Developing a new road connecting Vijayapuram in Tirupur (Kangayam road) and Periyapalayam in Tirupur (UttuMculi Road). Building a high-level bridge across river Noyyal to interconnect the above roads.

Source: Tamil Nadu : Improving Investment Climate, World Bank (2004)

increasing rapidly in Tamil Nadu with vehicle registrations growing by about 14% annually during the 1990s. However, road network supply and quality have not kept pace with the growing demand, leading to serious network deficiencies in terms o f slow response to growing demand, inadequate road capacity and maintenance, severe road congestion and high rate o f accidents.

126. Tamil Nadu has initiated measures to improve the transport network. The East Coast Highway undertaken by Tamil Nadu Road Development Company, a jo in t venture between GoTN and Infrastructure Leasing & Financial Services, i s an excellent example o f public private partnerships for rehabilitation and maintenance of roads, and could be applied more widely to upgrade the road network. The provision o f state equity and other financial support such as “viability gap funding” are also methods o f leveraging public funds, which GoTN i s considering. A clear regulatory framework for support o f public private partnerships needs to be put in place which would define the role o f the government and the private sector, lay out the risk sharing principles and also regulate the tar i f f regime for private roads. An important priority i s to press forward with fiscal reform to create fiscal space for investment in the infrastructure sector.

127. There are complex administrative barriers, high transaction costs and delays relating to shipping, truckmg, and customs administration o f exports and imports at major ports. The entire cargo transport chain f rom inland to a European port i s estimated to cost 15% higher, and many days o f delay, than the reform scenario.

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128. O n water supply, unreliability and shortage are a major weakness in Tami l Nadu’s physical infrastructure. T h e problem, however, i s not limited to Tamil Nadu alone. Across India about 54% o f businesses re ly on own wells. The problem in Tamil Nadu i s more acute because o f the absolute scarcity o f water resources in the state. Renewable freshwater resources are scarce, owing to high variability o f rainfall and resulting l o w river flows and periodic drought. Ground water has been overly exploited. Many o f the most important aquifers o f the state have been tapped at an unsustainable rate. Businesses report an average o f 11 days per month o f interruption in water supply from the public line, against the all-India average o f 4 days per month and only about ha l f day per month in Malaysia. The economic cost o f raw water i s high, but water user charges are wel l below cost recovery. Industrial consumers pay substantially higher tar i f f to cross subsidize domestic users.

129. Public and private partnership in infrastructure finance and development. Fiscal distress in Tamil Nadu (as wel l as in many other Indian states) i s a major constraint on the public financing o f badly needed infrastructure investment and maintenance. Planned capital outlays and net lending covering al l sectors i s about U S 7 5 0 mi l l ion in 2004/05, or 1.9% o f GSDP. This i s already much higher than the US$300 mi l l ion in 1997198 (1.2% o f GSDP) before the start o f the fiscal crisis. Assuming the success o f the fiscal adjustment, capital outlays per year are estimated to increase gradually to only about US$1.2 billion, or about 2.1% o f GSDP in 2007/08. This would, however, satisfy only a fraction o f investment demands.

130. Another constraint i s the limited local municipal govemment revenues from user charges, under assessment o f property taxes, and drying up o f institutional financing backed by state guarantees. Table 3.2 presents an assessment o f urban investment resource needs estimated by the Second State Finance Commission for Tamil Nadu’s public and private partnerships in infrastructure financing and development are therefore not only a fiscal necessity but also within the broader reform context in India o f creating sustainable financial structures which link liberalizing domestic capital markets with urban infrastructure financing needs.

Table 3.2: Sectoral Investment Requirement 2002-2007 Rs. crores

Town Local Body Corporations Municipalities Panchayats Total Yo Water Supply 506.2 673.4 1409.4 2589.0 31.9 Sanitation 409.3 391.3 41.7 842.3 10.4

Storm water drains 747.9 1101.6 684.5 2534.0 31.2 Roads 310.8 204.4 406.5 921.7 11.3 Lighting 43.2 43.6 125.3 212.1 2.6 Others 341.7 23 1 .O 282.9 855.6 10.5 TOTAL 2475.1 2679.0 2970.8 8124.9 100.0

Solid waste mgmt. 116.0 33.8 20.5 170.2 2.1

Source: State Finance Commission Report 11,2002

131. Tamil Nadu has been at the forefront o f experimenting with public-private partnerships in infrastructure financing and development (Boxl . l ) . These reforms have shown that private sector participation under appropriate regulatory arrangements would help not only address the problem o f l o w capital outlay owing to fiscal constraints but also highlight the benefits o f increased efficiency in infrastructure financing, delivery, and management. For example, in the East-Coast Highway (1OOkm) project, the GoTN’s contribution o f Rs.10 crore leveraged an investment o f Rs.51 crore f rom the private sector. It will also save the Government more than Rs.lOO crore through savings on future maintenance expenses and ensure sustained O&M spending for the entire 30-year concession period.

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132. Experiences with implementation have underscored the importance o f the following key factors for a successful public-private partnership pilot: providing selective credit enhancement to Urban Local Bodies and developing financing mechanisms with targeted use o f state government contribution and guarantees and link municipal financing with domestic capital markets; leveraging private equity and debt financing to multiples o f init ial public investment; user fees based on improved service delivery and cost recovery with cross subsidies between consumer categories; building in consideration o f operations and maintenance spending when planning a project; and proactive support f rom the government in inter- departmental co-ordination, close monitoring and trouble shooting; and transparency in bidding and contracting. In addition, a supportive political environment, regulatory certainty (for user charge regimes, concessions and contracting out, and dispute resolutions), operational restructuring to improve the functioning o f public institutions, and init ial equity participation are important in reassuring private promoters and attracting co-financing from financial institutions. The thrust o f reforms should be on sustaining and enhancing project cash flows, rather than relying on government subsidies and guarantees.

133. With industry and service sectors accounting for over 83% o f GSDP, Tami l Nadu i s among the more rapidly urbanizing states in India, which i s causing growing pressure on urban land and infrastructure. With publiciprivate collaboration, the Government has initiated a comprehensive assessment o f urban land markets and projections o f future land supply requirements in Chennai, the state capital. Such projections wil l facilitate the development o f an efficient, cost-effective, and financially sustainable urban land delivery system to meet the growing needs for urban infrastructure. The land market audit i s planned to be extended to selected cities and towns.

134. The Government has plans to issue an Infrastructure Policy Paper and establish an Infrastructure Development Board with membership o f the private sector to implement the gradual scale up o f public- private partnerships. Given the intrinsic link between urban land markets and infrastructure development, and based on international experience, pi lot projects in urban areas can be initiated to focus o n using land value capture to mobilize public finance, structuring partnerships with the private sector in finance and development, using value capture to finance housing projects for the poor, and integrating sustainable environment management with urban land management and infrastructure development.

135. Special economic zones. Special economic zones (SEZs) have been envisioned in India as a scaled-up version o f the export processing zones (EPZs) to overcome the constraints o f poor infrastructure and high regulatory burdens. G o T N has recently unveiled i t s own special economic zones policy providing broad guidelines with specifics being worked out. International experience o f EPZs and SEZs i s mixed, which can provide lessons for the design o f a policy and regulatory framework for SEZs. Unless SEZs can significantly overcome key constraints facing the private sector, SEZs wil l simply be a physical scaling up o f EPZs while experience o f EPZs in India i s mixed. State-wide broader regulatory reforms and infrastructure improvements continue to be important.

Institutionalizing Public and Private Sector Dialogue

136. To develop and implement a reform agenda that addresses complex regulatory and infrastructure issues will require an institutionalized dialogue between the Government, the private sector, and the c i v i l society for setting priorities and finding solutions. T h e recent establishment o f an Advisory Industrial Council, to act as a think tank for the government, i s an important step forward. The Council and i t s Consultative W o r h n g Groups can serve as an apparatus to formalize the dialogue between the Government and the private sector.

137. Tamil Nadu may draw valuable lessons f i o m the type o f Councils which has been key in the development o f international competitiveness in Asia, particularly in South Korea, Taiwan (China), Singapore, and some other countries. K e y factors contributing to the success of these institutions include political support, a clearly-defined decision-making authority in the Council, an accountable

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implementation mechanism, broad-based private sector participation that i s not perceive as representing special interest groups, and a public information and education campaign to build a shared consensus that can transcend any changes at the political level.

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IV. REINVIGORATIYG AGRICULTURE GROWTH

138. Whi le agricultural sector growth rates in Tamil Nadu were among the highest in India during the 1980s and early 1990s, deceleration in growth since the mid-1990s i s o f increasing concern to policymakers. During the 1980s agricultural GSDP grew at 3.4 percent, exceeding the all-India agricultural growth o f 2.9 percent. Adequate rainfall contributed to even higher growth in the early 1990s: between 1989/90 and 1994/95 agnculture grew by 7.2 percent in Tamil Nadu, compared with 3.1 percent in al l o f India. But between 1994195 and 1999/2000 agnculture in Tamil Nadu suffered from severe consecutive droughts and grew only 1.3 percent a year, compared with 2.9 percent for a l l o f India. As a result, the state’s apcul tura l growth rate during the 1990s was only 2.9 percent a year, compared with 3.2 percent for all o f India. Regression analysis showed that a one percent increase in rainfall relative to the mean i s associated with a 0.3 percent increase in real apcul tura l GDP relative to the trend agncultural GDP.

139. Faster growth in apcul ture i s central to rural development and poverty reduction in Tamil Nadu. Although agriculture accounts for only 14% o f Tamil Nadu’s GSDP and nonfarm income accounts for about 50% o f rural household income, farm income accounts for about ha l f o f household income for 35 mi l l ion people (56 percent o f the state’s population) who live in rural areas. Reinvigorating agnculture growth remains critical since a vibrant agriculture sector encourages industrial growth and farm income accounts for 78% o f the income o f the poorest 20 percent o f the rural population (with estimates ranging from 7.4 mi l l ion people (20.6 percent o f the rural population) to 11.4 mi l l ion (31.8 percent o f the rural population). Given the importance o f agriculture in the incomes o f the poor in Tami l Nadu, growth in labor-intensive agriculture could further reduce rural poverty through higher yields to small producers, higher real wages to agricultural laborers, and increased income and employment opportunities with forward and backward links to the rural non-farm sector

Salient Features of Agricultiire

140. There are three salient features o f Tamil Nadu’s agnculture that set the polit ical economy context for searching a viable strategy for revitalizing agriculture growth: water scarcity; the large shares o f rice and sugar (both water-intensive crops) in total irrigated land; and the dominance o f small and marginal farmers in overall agriculture production.

141. Water scarcity. Tamil Nadu i s one o f the driest states in India. Per capita availability o f water resources in Tamil Nadu i s only 900 cubic meters a year, compared with 2,200 cubic meters for a l l o f India. The state’s dry season lasts five months (January through May) even in good years, and severe droughts occur in 3 of 10 years, severely limiting cultivation o f crops between June and September. Irrigation through a combination o f canals, wells, and tanks increases the reliabil i ty and availability o f water for farming and i s essential for cultivating crops in much o f the state. But the seasonality and scarcity o f supply limit cultivation to only one crop per plot for most o f the state (in 1998/99 average cropping intensity was only 1.20 in Tami l Nadu, compared with 1.34 for al l o f India). 96% o f surface water for irrigation has been utilized and ground water resources are depleting.

142. Today the state relies equally o n surface and groundwater sources for irrigation, though i t s reliance on groundwater has been steadily increasing. Approximately 30 percent o f the net irrigated area i s watered by canals and 21 percent by tanks, while 49 percent i s fed by wells. The remaining area i s irrigated by other sources such as streams and springs. Rain-fed agriculture, employing approximately 25 percent o f farmers, accounts for 46 percent o f the net sown area o f 5.5 mi l l ion hectares.

143. The agricultural sector faces increasing competition for water f rom industry and domestic users and intensifying interstate competition for surface water resources. In many parts o f the state, the rate o f extraction o f groundwater has exceeded recharge rates, contributing to fall ing water tables. Of a total o f

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1.8 mi l l ion wells in the state, approximately 10 percent are now defunct. The depth o f bore wells in hard rock area has increased to as much as 600ft to 1OOOft. Today, use o f dug wells as a source o f irrigation i s only possible in canal and tank command areas; only bore wells remain operational in hard rock areas (mainly in the western part o f the state). Water quality i s also a growing concern. Effluents discharged from industries and heavy use o f pesticides and fertilizers have had a major impact on surface water quality, soils, and groundwater.

144. Rice and sugar. Rice and sugar, both water-intensive crops, account for nearly 40% o f gross cropped area and almost 70% o f irrigated area in Tamil Nadu. Rice dominates agricultural production, accounting for about a third o f total gross cropped area and nearly 60% o f irrigated area in Tamil Nadu (over 90% o f paddy i s irrigated). Pulses (18% o f total cropped area), mil let (1 l%), and groundnuts (10%) require less water than rice or sugar cane, and millet and pulses are grown almost exclusively on non- irrigated land. About 5% o f total cropped area i s devoted to sugar cane, al l o f it irrigated (accounting for almost 10% o f irrigated land). Cotton occupies about 3% o f cropped area, and about a third o f the cotton crop i s irrigated.

145. The livestock and fisheries subsectors are also important in Tamil Nadu. The state ranks second among Indian states in egg production and ninth in milk production.'* In 2001/02 Tamil Nadu accounted for approximately 6 percent o f national milk production and 11.9 percent o f egg production. The state i s also relatively well endowed with fisheries, accounting for 13.2 percent o f total marine fish production and 4 percent o f in-land fish production in India. In all, crop agnculture, livestock, and animal husbandry account for 92.2 percent o f total value added in agriculture and allied activities, with fishing accounting for 4.5 percent and forestry for 3.3 percent.

146. Dominance of small and marginal farmers. The average size o f individually-held farms i s only 0.91 hectares, with over ha l f the farms smaller than 0.5 hectares. Nearly three-quarters o f farms are smaller than 1 hectare, accounting for only 30.2 percent total cultivable land. In comparison, the average farm size in India i s 1.41 hectares, with 62 percent o f farmers holding less than 1 hectare.

Efficient W a t e r Resource Management

147. Efficient water resource management i s a key priority for not only agriculture but also the entire state economy. I t requires complex regulatory and institutional changes beyond the medium term. There are three main issues concerning the management o f water resources: fragmentation and lack o f strategic coordination; distorted pricing o f water; and decline in the quantity and quality o f public investment in irrigation structure.

148. Institutions for water resource management. Institutional weaknesses have undermined proper management and development o f water resources in the state. As i s common in many Indian states, inadequate priority to and funding for operations and maintenance led to rapid deterioration o f surface irrigation. There was also minimal involvement o f farmers in the operations and maintenance o f irrigation systems. Management o f water resources i s fragmented and lacks strategic coordination across key institutions. But recent efforts have been made to address many o f the issues plaguing the water sector.

149. Important legislation has been enacted to require rainwater-harvesting structure in al l public buildings to recharge the groundwater and arresting seawater intrusion; a massive and successful public campaign has been underway. The Government i s also moving away f rom fragmented management o f water resources toward a holistic river-basin framework, with the participation of a l l stakeholders. The

Ranks are computed based o n average production in Ind ian states between 1999 and 2001.

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River-Basin Management Council in two out o f 17 river basins has been established, a f irst in India. A basin perspective helps minimize negative impacts on downstream human and ecological uses. A groundwater policy i s being prepared. The state has drafted a Water Policy, initiated steps for irrigation management transfer, and passed a Groundwater Regulation and Management Act, one o f the f i r s t states in India to do so. The State Legislative Assembly passed the Tamil Nadu Farmers Management o f Irrigation Systems Bill (FMIS) in M a y 2000.

150. There are three priorities for more efficient institutional management o f water resources. The f i r s t i s the need to develop a state-wide water resources management strategy which examines competing uses for water and a strategic framework for inter-sectoral allocation o f scarce water resources. The second i s the need to introduce specific, legally enforceable water entitlements to various users in a river basin and or aquifer framework. The third i s the need to clarify and develop rules and a framework for interplay among various agencies and institutions o n the management o f water resources policy, Le., the River-Basin Management Council, farmers’ water user associations, local governments, and Water Resources Organization under the Public Works Department. Irrigation management transfer i s at an early stage in Tamil Nadu and water user associations are not yet fully functional, though the F M I S Ac t mandates the transfer o f irrigation management to farmers. Further, the separation o f a regulatory function and service delivery function, currently held by the Public Works Department, would be required.

151. Under the current system o f economic incentives (prices, subsidies, taxes), the cost o f water for farmers and other water users does not reflect the scarcity value (opportunity cost) o f water. Throughout India, farmers using surface water for irrigation f rom canals or tanks are implicit ly subsidized because water charges fal l short o f operations and maintenance expenditures. Between 1990 and 2002 farmers using groundwater for irrigation in Tamil Nadu also benefited f rom free agricultural power supply. Subsidizing irrigation water means that the environmental costs o f water use are not being internalized, reducing incentives for water conservation, encouraging the cultivation o f water-intensive crops, and contnbuting to environmental degradation. The irrigation and agricultural power subsidies have contributed to the state’s large fiscal deficit. These subsidies also have a high opportunity cost in terms o f other social and economic expenditures foregone.

Pricing o f water and electricity.

152. In 2003, the Government o f Tamil Nadu announced increases in irrigation water charges. Previously, water charges were levied by the Govemment o f Tamil Nadu at a base rate (which varied according to crop, season, and soil quality) plus an additional charge equivalent to six times the base rate. This additional charge was transferred to the local panchayats. Beginning in July 2003, an additional water charge o f Rs.150 per hectare was imposed, de-linked f rom any additional cess. With this change, farmers were to pay the original charge plus the Rs.150 per hectare. In addition, the F M I S A c t empowered water user associations to charge users between Rs.250 and Rs.500 per hectare. This fee could be retained by the associations for operation and maintenance o f the systems turned over to them. These provisions for irrigation water charges allowed full cost recovery o f required operations and maintenance expenditures. The extent to which farmers were actually being charged the proposed water rates i s unclear.

153. The agncultural power tar i f f introduced in March 2003 included a flat rate for unmetered connections o f Rs.250 per horsepower a year and Rs.0.20 per kilowatt-hour for metered connections. A long with the reintroduction o f the agricultural power tariff, the government announced an income support scheme for smallholders and marginal farmers. Under the income support scheme, the Government o f Tamil Nadu provided smallholders and marginal farmers a transfer o f up to Rs. 1,250 a year. This was a significant step toward creating a more direct and transparent system o f subsidies to farmers and other target groups and ensuring the separation o f commercial operation o f the power utility f rom the need for subsidy. However, in a recent development power supply to agriculture i s n o w free

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again and the direct subsidy scheme to farmers has been replaced by non-transparent budgetary support to the TNEB.

154. In any case the flat rate charge o f Rs.250 a year for a five horsepower pump set would have had only a small effect on net returns to land and management, reducing them by only 4.9 to 6.5 percent. Costs o f crop cultivation using well irrigation would have risen by only Rs.625 per hectare (annual charge pro-rated for one season) to Rs. 1,250 per hectare (for sugar cane grown over eleven months). However, such increases were also against the background o f repeat droughts starting in 1999 which have reduced significantly agriculture growth and income (para. 17).

155. Increases in electricity charges would have litt le effect on overall r ice production and market prices but a major effect on sugar cane production. Since only about 10 percent o f rice area cultivated i s irrigated with wel l water (about 200 thousand hectares), changes in electricity pricing would have only marginal effects o n production. And since rice i s also supplied by net public distribution (averaging 1.2 mi l l ion tons a year f rom 1997198 to 2001/02, 18 percent o f net production) and private market trade from neighboring states (estimated at 1 .O-1.3 mi l l ion tons in the drought year 2002/03), the effect o f lower r i ce production f rom wel l irrigated areas on market prices o f rice would l ikely be small. Impact o n sugar cane production would be much higher however, as essentially a l l sugar cane i s irrigated in part with well water.

156. If electricity charges are raised to the estimated marginal economic price o f electricity to agriculture o f Rs.3.1 per kilowatt-hour, irrigation costs would r i se to about Rs. 4,600 per hectare for paddy and sugar cane, reducing returns to land and management by 35.9 percent for paddy and by 23.8 percent for sugar cane. Likewise, total returns to land, labor, and capital (value added) fall sharply for paddy and sugar cane irrigated by wells when the cost o f electricity for pumping i s included.

157. I t has been well recognized in India that the power subsidy i s regressive, and farmers most at risk f rom drought are those without a pump set. But the reality i s that nearly three-quarters o f farms are smaller than 1 hectare, which may not be a l l poor, but they are not too far f rom subsistence living. Unless an integrated service package i s provided to farmers, reducing power cross-subsidy i s polit ically difficult. As a way to move forward, Tamil Nadu may carry out a small scale experiment o f providing a community o f farmers with the best facilities they need and assuring them o f a minimum o f their present income levels and asking them to pay for power and then examine whether their incomes levels increase or decrease in this experiment.

Challenges of Agriculture Diversification

158. Even with efficient management o f water resources, diversification into higher value, less water- intensive products, such as fruits, vegetables, spices, and livestock products, may be one o f the most promising sources o f future agncultural growth, simply because o f the aggregate scarcity. Tami l Nadu’s agro-climatic conditions are wel l suited for diversified agnculture. Rapidly increasing incomes and changing patterns of food demand also provide strong impetus for diversification. Increased agricultural diversification and private investments in processing for many o f the higher value agncultural commodities are l ikely to generate new rural non farm employment opportunities and contribute to higher rural incomes.

159. Notwithstanding its importance, there are daunting challenges in diversifying agriculture. Simply raising water and electricity tariffs has not only met political resistance but also would not provide sufficient incentives for farmers to move toward less water intensive crops. Currently in addition to having price incentives to grow rice and sugar, farmers engaging in rice and sugar production also have an extension system supporting them and a government procurement system to protect them against crop failures associated with droughts, market risks, and infrastructure constraints which reduce farm gate

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prices. Pure market pricing solution and deregulation wi l l not work in a complex context o f political economy and institutions.

160. Broader pol icy and institutional reforms are required to form a coherent package. The required reforms are: decentralizing a traditionally top-down centralized extension system which cannot respond to market signals for more diversified agnculture; facilitating efficient markets; developing a rural credit market, and developing an insurance and safety net program to cushion against the r i s k o f diversification particularly for small and marginal farmers who rely mainly on agnculture subsistence income; and a delivery package to improve farmer income associated with gradual adjustment o f input pricing.

161. Decentralizing the extension system. The agricultural extension system in Tamil Nadu, l ike the rest o f the country, i s s t i l l organized around a modified Training and Visit approach and continues to focus on major food-grains. There i s little coordination among l ine departments (agricultural, animal husbandry, fisheries) in their extension approach. The highly centralized extension system cannot meet the needs o f diversified crops and products. A wide range o f product types would require a decentralized and flexible extension system that can respond to market signals.

162. The extension system i s slowly changing, however, and the promotion o f public-private partnerships in extension i s encouraging and offers potential for both cost-savings and greater efficiency. The Govemment o f Tamil Nadu also plans to link agricultural, horticultural, and agricultural engineering extension systems and units to improve the extension capacity for horticultural development. Related to extension, an assessment o f the state's comparative advantage in producing higher value crops for the domestic and export markets would also help in setting future research and development priorities. Re- orienting agricultural research to make it more farmer-responsive would likewise improve the output o f a system that has enjoyed much success in rice technology development in the past.

163. Facilitating efficient markets. Wel l functioning agricultural markets are also important for successful agricultural diversification. Unlike most Indian states, where wholesale marketing i s restricted to regulated markets, Tamil Nadu permits traders to transact sales outside o f regulated markets. Private markets account for about 90 percent o f the statewide trade in major crops. Regulated markets, in which licensed traders bid for farmer produce through a tender system, account for only 10 percent.

164. Further, if recent policy reforms removing restrictions o n purchase, movement, stocking and sales o f paddy and 13 other crops by the private sector are consistently implemented at the local level, they can be expected to improve marketing efficiency, reducing the margin between producer and consumer/export prices.lg Reductions in marketing costs are also necessary in order for production increases to lead to higher agricultural incomes, particularly for perishable high-value products (e.g., fruits, vegetables, animal products). Private investments in processing and marketing horticultural and export crops have enjoyed some success (for example, turmeric exports f rom Erode). Contract fanning involving business agreements for the purchase of outputs and often the provision o f inputs and extension advice i s increasing, particularly for sugarcane, cotton, and horticultural crops.

165. Inadequate transport network including major ports i s a major constraint to well-functioning agriculture markets as it impedes the efficient transportation o f agnculture products fi-om farm gates to consumers, increasing transportation and delay costs. These are particularly important constraints for high-value agriculture products such as cut flowers, vegetables, h i t s , and fishery products.

l9 In May 2003, following the February 2002 central Government order removing licensing restrictions on rice and 13 other crops, the state Govemment withdrew i t s licensing system for these crops. Restrictions on purchase, movement, stocking, and sales o f these commodities have been removed, though some provision remains for Govemment intervention in the case o f high market prices for goods distributed through the public distribution system.

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166. Developing safety nets. Whether a p c u l t u r a l diversif icat ion reduces rural poverty in Tami l Nadu will depend o n the extent to wh ich small and marginal farmers, who dominate T a m i l Nadu’s agriculture (para.l46), adopt n e w technologies and have access to markets, the magnitude o f employment and real wage rate gains, and the size o f linkage effects with rural non-agriculture. Furthermore, periodic droughts bring about volat i l i ty in production and income, dramatically increasing vulnerabi l i ty for small and marginal farmers, w h o re ly o n subsistence living and have less non-farm income and assets t o mit igate the impact o f volat i l i ty. The implications o f an agricultural diversification strategy involving higher risk crops and capital-intensive technologies (drip irrigation) must be assessed. Th is assessment should rev iew crop and drought insurance instruments, and the potential for innovations in these instruments to enable rural farmers, part icularly poor farmers, t o better manage risks.

167. Increasing employment and earnings in the dry season i s especially important for the ru ra l poor. Increased avai labi l i ty o f water and greater eff iciency o f water use in the dry season ( for example, through the widespread adoption o f drip irrigation) cou ld enable cult ivat ion o f crops year-round, p rov id ing employment in agricultural production and processing. Dissemination o f n e w product ion technology and establishing markets for dry season crops remains an important unresolved issue, however. Contract farming (Box 4.1) may help overcome these problems, i f competit ion between f i r m s helps farmers maintain their share o f the value o f the f inal product sales.

Box 4.1: Contract farming in Tamil Nadu

Contract farming involves a business agreement between a farmer and a f i in which the f i i provides inputs, extension services, processing and a ready market in return for a guaranteed source o f supply o f the output product. Such arrangement between sugar m i l l s and cane farmers has long been practiced in Tamil Nadu and other parts o f India. For other products, however, restrictions on private sector trade motivated by a general mistrust o f traders, along with the structural characteristics o f output markets (including the inability to differentiate products by quality or brand) have greatly limited the scope o f contract fanning.

Rice: Beginning in a limited way in 2002103, EID Parry sold approximately 60 tons o f improved seeds for super fine quality ‘Ponni’ rice (enough for about 800 hectares) and provided extension services to sugar cane farmers who sold sugar cane to the f m ’ s sugar mill in Cuddalore, but were also willing to grow rice. With the improved rice technology, paddy yields were approximately 25 percent higher than normal yields o f 3.75 tonshectare. Moreover, because o f drought, market prices were about 20 percent higher than the previous year. EID Parry later purchased the output. In the absence o f an explicit sales contract, though, the f i i r i sked not being able to purchase supply for i t s rice mi l l s . The entrance o f large private fim into rice markets has only been possible wi th the removal o f stocking l i m i t s (in M a y 2003), and other restrictions on movements o f paddy and rice.

Cotton: Cotton contract farming started in about 1200 hectares in the 2002-03 season. The farmers have the option to sel l cotton to the contractor or to any other b r under the market prices prevailing during harvest period. For the services provided by the contractor, a nominal charge w i l l b evied on the farmer on a unit area basis.

Gherkin: Gherkin cultivation and processing started in India in the early’ 90s and at present i s spread over 7,900 hectares in the three southem states o f Karnataka, Tamil Nadu and Andhra Pradesh. There are about twelve companies operating in the state and each company has agricultural extension team o f 5-25 who identify farmers and then enter into a buyback contract wi th them.

ct farming for poultry i s also practiced in Tamil Nadu. For broilers, fim supply chicks, ines and technical guidance to the farmers. The fm then buy the birds when they are eight

weeks old at a predetermined price.

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168. Improving Public Expenditure. Although public expenditure o n agnculture in Tamil Nadu i s relatively high among Indian states, the composition o f expenditure i s a problem. Expenditure on agriculture, allied activities, and irrigation as a share o f agricultural GSDP i s higher in Tamil Nadu than in most major agricultural states in India. Between 1998 and 2000, public expenditure on agnculture equaled 11 percent o f total agricultural GSDP in Tamil Nadu, compared with 7.8 percent in al l o f India.20 Public agricultural capital expenditure in the state i s relatively l o w as a share o f agncultural GSDP compared with the all-India average, while the opposite i s true o f revenue (i.e., current) expenditure. T h i s i s a situation for concern since capital investment i s important for future growth. Furthermore, a large share o f revenue expenditure i s incurred on staff salary, and food and irrigation subsidy, leaving operating expenses under funded. Gross fixed capital formation in agnculture increased by 15 percent during the 1990s, due pr imari ly to private capital formation, which accounted for 88 percent o f gross fixed capital formation in agriculture.

169. There remain, however, important roles for the public sector in promoting agro-food system and agro-enterprise development. In addition to policies that establish “rules o f the game” and address market failures, public investments in the road network to strengthen connectivity can contribute to reduced costs o f marketing. Reorienting public expenditure f rom consumption to growth-enhancing areas in key public goods such rural roads, markets and agncultural research and extension will facilitate productivity improvements and diversification o f agnculture to higher value products. Tightening competition for l imited fiscal resources heightens the urgency o f appropriate public expenditure reallocation. Institutional reforms within government departments to ensure improved quality o f delivery o f rural-related public goods and services i s also important (see Section I1 on fiscal reform and V on public administration reform).

170. Greater attention i s also needed for modernizing irrigation infrastructure and scaling up the adoption o f water-saving irrigation technologies. W h i l e the use o f sprinkler and dnp technology has been promoted in the state, their high capital cost constraint widespread adoption by smallholders and marginal farmers. More affordable technology or a suitable system o f targeted subsidies should be developed to increase the use o f sprinkler and drip systems.

20Agricultural public expenditure as a share o f expenditure on Economic Services and Agricultural GSDP are averages o f data from 1998/99-2000/01.

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V. IMPROVING PUBLIC A D M I N I S T R A T I O N AXD ENHANCING SERVICE DELIVERY

171. Whi le the main objective o f fiscal consolidation and reform i s to correct aggregate expenditure imbalance to create the fiscal space for priority spending in infrastructure and social sectors, i t i s critical that the expenditure allocated to the priority sectors and areas be spent efficiently. T o this end, the strengthening o f public expenditure management and financial accountability would need to be supported by public administration reform to enhance service delivery.

172. Tami l Nadu has traditionally had capable public administration. I t has moved f rom a near- average to a high-performing state as indicated by the HDI, which i s measured by longevity, education, and command over resources. Tamil Nadu’s HDI, though ranked seventh place in 1981 rose to the third highest among 29 Indian states in 2001. Tamil Nadu has also done well in delivering key services: A recent survey conducted by the Public Affairs Center reveals that the state has the country’s best public distribution and school education systems, and the second best public drinhng water and road transport services after Gujarat. This, o f course, i s not a uniform picture: health services, for example, are ranked fifth.21 Yet, notwithstanding this impressive record, Tamil Nadu faces several critical challenges that need to be addressed to preserve and extend the gains made so far.

173. T o further improve public administration and enhance service delivery, the reform agenda would need to focus o n the following areas which cut across sectors: (i) administrative reform to improve the efficiency o f the government by rationalizing and restructuring govemment functions, simplifying decision-malung processes, and improving the stability o f staff tenure; (ii) improving services with a large public interface through a combination o f measures, including agency reform and e-governance; (iii) transparency and anti-corruption by overhauling the public procurement system, ensuring the public’s right to information, and strengthening the anti-comption enforcement machinery.

Rat ional iz ing t h e Role of Government

174. The c iv i l service in Tamil Nadu has proliferated in the last twenty years: Tamil Nadu today possesses the highest ratio o f c iv i l servants per hundred population in India o f any major state after Punjab. Whi le restructuring the government has become imperative because o f the fiscal crisis, a fundamental issue i s to rationalize the role and functions o f the government in an increasingly market- driven economy.

175. T o rationalize and restructure the c iv i l service and improve i t s productivity, the Government constituted a Staff and Expenditure Reforms Commission (SERC) in December 2001 to systemically review and realign the roles and responsibilities o f each o f the 140 departments and identify redundant departments/functions/posts, including areas where the government should exit and let the private sector take over (Box 2.2). The exercise was carried out with the benefit o f extensive consultation within the govemment, including with staff associations and unions, as wel l as consultation with the public.

176. The SERC reports have identified about 85,000 surplus posts, and 113,000 vacant posts made feasible by hiring freeze. The surplus posts are targeted mainly at lower-level administrative posts and at those government functions n o longer required in an increasingly market-oriented economy. The rationale for eliminating these posts i s three-fold: (a) they are overstaffed in terms o f existing work norms; (b) they are overstaffed in terms o f the work that can be done by new technology; and (3) these tasks can be outsourced. There are n o cuts in teachers, doctors and nurses, and police in front l ine service delivery.

’’ Public Affairs Center, a well-known NGO in India, “Study of India’s Public Services: Benchmarks for the New Millennium”, April 2002.

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177. The reduction in the core civil service size (posts) by 2007/08 (from 2002/03) can be achieved by abolishing 85,000 posts using 2002/03 as the base year. The abolishing o f the surplus posts will enable a more efficient allocation o f staff across departments within the targeted ceiling. The Government has commenced the implementation o f the SERC’s recommendations by issuing orders to abolish 40,500 vacant surplus posts; an additional 10,000-15,000 posts which are currently live, are to be abolished in 2004105. Downsizing has been diff icult to accomplish in India, and Tamil Nadu could prove to be no exception, notwithstanding solid gains to date. Moreover, the recent decision o f retaining the services o f 15,500 temporary workers hired last year i s not an encouraging s i g n o f government commitment.

178. The Government has also issued an order allowing for the “progressive” outsourcing o f a l l Group D categories (e.g., sweepers, security personnel), with the exception o f office assistants, provided that new contractors give preference to existing employees on the nominal muster r o l l (NMR) or receiving daily or consolidated wages. The Government also plans to take actions on the SERC’s recommendations to further streamline public administration.

Stremillining Decision -Making

179. volume o f paper work and multiple and often duplicating layers.

L i ke many Indian states, the process o f decision making i s cumbersome and involves a large

180. To simplify the decision-malung process, the SERC also reviewed the functioning o f the Secretariat, focusing on three issues: (i) improving efficiency through delegation to heads o f departments, level-jumping, the introduction o f the single-file system, and computerized fi le monitoring; (ii) greater flexibility for redeploying staff; and (iii) tightening up on discipline by tracking attendance. The Government issued an order in March 2002 permitting level-jumping-which reduces the number o f layers through which a f i l e passes to n o more than three-for a variety o f subjects including, among others, transfers, granting o f annual pay increments, leave matters, and disciplinary cases. Another order in November 2002 allows departments to introduce the single-file system, wh ich permits heads o f departments to send an entire fi le directly to the Secretariat for approval o n various subjects. A comprehensive e-governance strategy i s being formulated to increase transparency, improve efficiency, and speed up decision making.

Improving the Stability of Staff Tenure

181. Tamil Nadu i s not immune to the national phenomenon o f frequent staff transfers, which undermines service delivery by disrupting managerial continuity and generates corruption by creating a market in posts.

182. Responding to the problem o f pre-mature transfers, the Government introduced a system o f formal counseling for transfers in both the Health and Education Departments. The new system i s aimed at reducing discretion in the process by holding annual, open consultation to allocate postings in the presence o f applicants based on transparent and publicly-known criteria. In 2004/05, the Government plans to introduce computerized counseling in health and education. The Government has also recently issued a Government Order (GO) covering the entire c iv i l service. The GO specified transferring authorities, established norms for three- to seven-year tenure, l imited transfers to 20% o f cadre strength and to the season only, and announced the creation o f a public transfer database o n the internet to track transfers over time. The creation and implementation o f a public transfer database o n the Internet t o track transfers will provide a basis for formulating additional measures to improve the transfer process. Recent announcement o f transfers (after national elections) however raises questions about the implementation o f the GO.

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Improv ing C r i t i c a l Services w i t h a Large Publ ic Interface

183. Whi le Tami l Nadu has done wel l in service delivery in some key areas relative to the rest o f the country, there i s s t i l l room for improvement. A number o f reforms are ongoing; these include improving

Box 5.1: Rural Access to Services through the Internet (RASI) in Tamil Nadu RASI delivers a variety of services to rural villages using wireless technology connected to the state’s fiber optic network and the Internet Service Provider. I t is based on public-private partnerships involving the Indian Institute o f Technology Madras, N-Logue, a private company, the Center for Entrepreneunal Development in Madurai, and the GoTN. In villages located in Melur Taluq and Madurai districts, the hosks were located in a prominent spot in the village. Villagers can send application forms on l ine to govemment offices for various certificates, which are collected by the operator and delivered to the applicants by hand. A web-camera installed at the kiosks allows people suffering f rom eye defects to send photos of their eye to Madurai’s Eye Hospital for an init ial analysis; this has been extended to photographing diseased crops for analysis at the local agricultural university. When several cases o f malaria broke out in a nearby village, health officials received an e-mail and amved the following day. Critical information is online, such as crop prices, canal irrigation timings, guideline values, and eligibility criteria for schemes. RASI also offers business applications, such as linking villagers to buyers and sellers o f farm equipment or providing them access to l i fe insurance offered through the website o f the L i fe Insurance Corporation of India.

the Registration Department by introducing a computerized guidance value calculation software package for use in i t s sub-registries, and promoting the development o f kiosks in villages to improve rural service delivery and empower rural citizens (Box 5.1). Rural land records have also been fully computerized. Urban municipalities have computerized many services, including the issuance o f birth and death certificates, trade licenses and the collection o f property taxes and water charges. Metrowater, Chennai’s public water utility, i s a model o f how to deliver services in a citizen-friendly manner.

184. Over the next few years, in addition to policy and institutional reforms in critical sectors such as water supply and sanitation, education and health to enhance service delivery, the Government plans to focus on improving 10 critical services with a large public interface, including regional transport services, commercial tax, stamps and registration for property transfers, district administration, and local bodies. It plans to accomplish this through a combination o f measures such as e-governance, process reengineering, citizens’ charters, and partnerships with the private sector.

Procurement Reform

185. Tamil Nadu was the first Indian state to introduce legislation, in October 1998, to improve transparency in public procurement and to regulate tendering and contracting procedures o f govemment departments, statutory bodies, public sector enterprises and other local bodies. The A c t has become a model for other. states wishing to reform public procurement (e.g., Karnataka, Andhra Pradesh, and Punjab). The detailed rules and tendering procedures under the Act took two years to finalize and the A c t and the Rules came into effect only in October 2000.

186. The pace o f procurement reform has been accelerated, focusing o n the implementation o f the Act. I t has completed a three-year comprehensive procurement reform action plan, based mainly on a study carried out by the Wor ld Bank for the Government.22 A dedicated central “Procurement Procedure Cell” was created in the Department of Finance in October 2002 to supervise the implementation o f the agreed reforms and to serve as a central pol icy and oversight unit for public procurement in the state. Consultants have been selected for some high-priority items in the action plan, e.g., revision o f Finance,

22 In November 2000, the World Bank carried out a Country Procurement Assessment Review (CPAR) for India, and selected Tamil Nadu as the first state to review, particularly to assess the effect o f the Transparency Act. The report made a number o f recommendations to further improve the efficiency, transparency and accountability o f public procurement procedures and to minimize opportunities for corruption, as also to introduce modem concepts and technology in the procurement system.

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Accounts, Public Works codes and Manuals, and preparation o f a set o f Standard Tender and Contracts documents.

187. The implementation o f the procurement reform action plan i s expected to be completed over three years (2004/05-2007108). This will include: setting up a complaint/challenge/appeal mechanism; finalizing and issuing five sets o f Standard Bidding Documents; finalizing the revision o f Finance, Accounts, and Public Works codes; improving works procurement procedures; introducing code o f ethics for officials and the business community and tightening enforcement; evaluation o f reservation and exemptions with a v iew to provide a level-playing field; enlarging the scope o f rules to cover consultant selection procedures; and issuing guidelines and directives on procedural improvements.

Right t o In forn ia t ion

188. Tamil Nadu passed the country’s f i rs t Right to Information (RTI) Ac t in 1997; the A c t itself, however, was flawed. Exemptions are numerous and broad enough to make virtually al l government information o f f limits to the public if interpreted literally. W h i l e most RTI Acts in India, and globally, provide for automatic and pro-active release o f certain categories o f information on a suo-motu or routine basis, there i s n o such provision in the Tamil Nadu law. It also lays down n o penalties for non-compliance and fails to establish an independent channel for appeals. The law falls below GoI’s standards set in the Freedom o f Information Ac t (2002), as well as the standards o f state laws in Delhi, Karnataka, and Maharashtra.

189. The Govemment announced in the 2003/04 Tamil Nadu Governor’s Address the need to revise the kght to Information legislation. The Govemment i s currently preparing a new draft l aw that will provide for minimal exceptions, an independent appeals process, penalties for non-compliance, and more automatic disclosure o f information by departments. The G o T N hopes to submit this bill to the state legislature soon, for the purpose o f providing a sound basis for implementation over the next three years.

Enforc ing Ant i -Corrupt ion

190. In addition to ongoing systemic reforms to prevent corruption (e.g., procurement reform, business deregulation, e-governance, and fiscal transparency), enforcement efforts need strengthening. The Vigilance Commission and i t s investigating agency, the Department o f Vigilance and Anti-Corruption (DVAC) function as government agencies. Quite unlike neighboring Karnataka’s independent L o k Ayukta who has the authority to investigate both corruption cases and grievances arising out o f maladministration involving c iv i l servants and Ministers and exercises supervisory authority over the police wing o f the L o k Ayukta. The performance o f the D V A C has been mixed, with high conviction rates drawn from a very small number o f registered cases, mostly easy-to-prove ones for whom traps were set. Only 1% o f petitions fi led with the D V A C between 1993/94 and 2002/03 resulted in prosecution in any given year. Neither the Vigilance Commission nor the D V A C possessed a public website to disseminate performance information.

19 1. Building on various, ongoing governance reform initiatives, a Government Order was issued in February 2004 to establish a high-powered Govemance Reform Commission to: (i) prepare an action plan with monitoring indicators for improving 10 critical services with a large public interface; (ii) suggest the structure and modality for an independent institutional mechanism to oversee public grievance management and handle corruption complaints in service delivery; and (iii) recommend measures to strengthen the government’s capacity to implement a broader program o f governance reform including modalities for encouraging well-informed public debate and building broad-based consensus o n pr ior i ty issues. The Govemance Reform Commission is, however, yet to begin functioning. Meanwhile, the government has announced the constitution o f ‘Service Delivery Improvement and Grievance Redressal

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Committees’ at the levels of district, department and secretariat departments wh i le a state-level jo in t counci l headed by the Chief Secretary wou ld be reconstituted.

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VI. STRENGTHENING POVERTY MONITORING AND EVALUATION

192. Notwithstanding good progress in reducing poverty and improving human development indicators in Tami l Nadu, poverty remains high, with 12-17 mi l l ion out o f 62 mi l l ion people s t i l l below the poverty l ine (para. lo). There are also emerging human development challenges (paras 12-13). Whi le broad-based economic growth i s necessary for poverty reduction, programs targeted at the poor, disadvantaged and vulnerable are equally important to ensure that growth i s more broadly shared and that the poor will be protected against the potential impact o f for example the reduction o f subsidies.

193. Tamil Nadu has a plethora o f poverty-reduction programs. One o f the most important ones i s the public distribution system for food security. Another well-known program i s the Noon Meal Scheme to provide incentives, particularly to the poor children for school enrollment. I t will be important to strengthen monitoring and evaluations o f targeted poverty-reduction interventions in order to in form better ways to improve targeting and rationalization across programs.

194. Effective poverty targeting needs to start with the identification o f the poor and understanding the nature o f poverty (both income and non-income) and identifying the key determinants o f poverty. F rom available data - mainly NSSO, National Council o f Applied Economic Research and National Family Health Survey (NFHS) -some important lessons regarding the relationship between poverty in Tami l Nadu and geography, asset ownership, occupation, demographics, health and education, and agnculture could be drawn.

195. These messages yield a number o f broad implications regarding targeted poverty-reducing programs. In terms o f targeting, there appears to be a case for paying special attention to the rural areas in the Coastal Nor th and the South, and possibly to the urban areas in the Coastal North. Scheduled Castes and Scheduled Tribes (SCISTs) also appear to face particular barriers to upward mobility, and the data suggest that these stem at least in part f rom three sources: access to land, education, and regular non-farm employment. Indeed these three barriers, although especially acute for SC/STs, tend to be characteristic o f the poor more broadly. Addressing them will therefore be a vital part o f any poverty alleviation strategy pursued by the state.

196. There are a great many questions regarding poverty in Tamil Nadu that are diff icult to answer for lack o f data. The l i s t o f questions which remain unanswered i s extremely long, but a couple o f examples may serve to illustrate the consequences o f data limitations facing poverty analysis.

197. First, since National Sample Survey (NSS) data are only representative at the NSSO regional level, constructing more disaggregated regional poverty measures has not been possible. From the point o f view o f policymakers, and in particular against a background o f decentralization, there i s a real interest in knowing more about the geography o f poverty at the level o f 29 districts or the 384 blocks. For a state as large as Tamil Nadu with a population o f 62 mill ion, data disaggregating at the four regional level can not provide detailed geographic profi le o f the poor-i.e., where the poor are. Methods have been developed in recent years to combine survey with census data so as to produce such detailed geographic profiles o f poverty, but such methods have not yet been implemented in India. Such information i s thus unlikely to become available in the short run.

198. Similarly, although we can glean some insights from N F H S data, we cannot paint a very detailed picture o f urban poverty. This i s clearly unsatisfactory since urban poverty promises to be a growing challenge with the rapid urbanization o f the state.

199. Second, although data such as the NFHS do provide us a r i ch picture o f women’s quality o f life, i t has l i t t l e data regarding income or consumption. This makes it diff icult to map these indicators into an understanding o f poverty. Given that the Tamil Nadu government has been laying increasing emphasis

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on assisting women, it would no doubt be useful to systematically identify the challenges facing poor women. Although constraints on employment and earnings appear to be an important deterrent to upward mobi l i ty amongst women, as wel l as other disadvantaged demographic groups, especially SCISTs, we are not in the position to elaborate on the nature o f these constraints, particularly in urban areas.

200. Developing a comprehensive poverty reduction strategy wil l involve more investment in poverty monitoring. This i s obviously a grand undertaking, but the recent Below Poverty L ine (BPL) survey i s an important step in this direction. I t asks a number o f important questions regarding household characteristics, including income, asset ownership, and a few occupational and demographic characteristics. Since i t i s a census, the B P L i s amenable to the addition o f modules, which could be used to acquire data representative at least at the district level. Such an undertakmg would be considerably facilitated by virtue o f the fact that much o f the necessary survey infrastructure i s already in place. The B P L therefore offers a valuable opportunity to fill gaps in our knowledge regarding the nature and determinants o f poverty in Tamil Nadu. M u c h remains to be learnt, however, about the quality and reliabil i ty o f the BPL data that are currently being collected.

201. The BPL type o f surveys can also be supplemented by sectoral MIS data. Various government departments in Tami l Nadu such as Social Welfare, Education, Health, and Rural Development collect and maintain useful data such as nutrition, infant mortality, primary school enrollment and dropout rates, maternal mortality. One deficiency i s that these data f rom various departments are not integrated. With the ambitious e-governance project initiated to modernize the information system o f the state government, a useful and important step can be taken to establish a central poverty and human development monitoring unit under the Planning Department to integrate monitoring (currently done by each o f the concerned departments) for synergy and a common database that will facilitate systematic evaluations and pol icy feedback on poverty-reduction interventions.

202. The capacity to monitor the progress o f poverty and human development and link that with overall policy and poverty-reduction interventions remains critical. There i s also scope for aligning the various programs listed in the Tenth Plan to improve coordination and targeting: many programs are not coordinated, with multiple, overlapping and sometimes different objectives. T h e government has plans to conduct evaluations o f key programs. The Noon Meal Scheme may be a good program to begin the exercise. A comprehensive and well-coordinated monitoring and evaluation system will be essential t o streamline the various projects currently envisaged and further strengthen the government's efforts in poverty reduction.

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VII. REFORNI CHALLENGES AKD R I S K S

203. Tamil Nadu faces the longer-term challenge o f reform for accelerating economic growth and reducing poverty. Repeated droughts and growing waters shortages have heightened the importance o f structural transformation. Such transformation will reduce the vulnerability o f the economy to periodic drought, and free up scarce water resources to higher value-addition activities in the industrial and service sectors. The faster growth o f these two sectors would help absorb agriculture surplus labor and reduce currently high unemployment rate o f the state.

204. poverty are:

Reform priorities for the structural transformation to accelerate economic growth and reducing

0 Fiscal reform remains an immediate development challenge for Tamil Nadu, and India. Fiscal stabilization, correcting aggregate imbalances, and improving the composition o f expenditure i s critical for creating the fiscal space for priority spending in infrastructure and social sectors.

0 Fiscal reform must be accompanied by strengthened public expenditure management and public administration to improve the effectiveness o f public spending and service delivery.

0 Fiscal adjustment alone without a complementary focus on the investment climate and economic growth i s insufficient. Faster economic growth positively influences not only debt sustainability but also employment and income generation, facilitating larger distribution o f reform gains.

0 Even assuming the success o f fiscal adjustment in accordance with the MTFP, public investments in infrastructure and basic services are l ikely to remain a fraction o f investment needs. Thus, public-private partnerships in infrastructure financing and development under an appropriate policy and regulatory framework are essential.

205. I t needs to be understood that many important policies are not within the purview o f the state govemment. Policies o f the central government affect fiscal sustainability and growth in states. These central policies include the share o f the state in central tax devolution, the introduction o f VAT, a macroeconomic framework that may affect interest rates on state debt, regulatory policies o n private sector activities such as labor market regulations, business exit and bankruptcy procedures, and infrastructure policies and development affecting major ports, air markets, inter-state highways etc.

206. Agenda for fiscal reform. Putting Tami l Nadu’s fiscal reform in the Indian context, fiscal consolidation remains the most serious macroeconomic challenge facing India, with the general govemment deficit estimated at close to 10% o f GDP and the debt/GDP ratio at 81% in 2003/04. Almost ha l f o f the consolidated fiscal deficit i s made up o f states’ deficit. States’ fiscal reform has shown to be difficult, i t s progress uneven across states and several states have experienced varying degrees o f pol icy reversals. Reforming c iv i l service salaries, pensions, subsidies improving tax administration and reforming the power sector remain polit ically challenging. State reforms wil l be accelerated by the linkmg o f central fiscal resource transfers to states with their fiscal performance. In this regard, strengthening o f the initiatives already undertaken by GoI, such as the Fiscal Reforms Facility, will be important. A schematic l i s t o f necessary reforms in the broad area o f fiscal and public expenditure management i s presented at Annex 2.

207. MTFP will need to reflect the vision o f the state in consonance with the state’s Fiscal Responsibility Act. To operationalize the development vision, policy formulation and budgeting need to be better integrated by ensuring that fiscal constraints are realistically identif ied and appropriately incorporated into each o f these processes. As recognized by the GoTN, the fiscal crisis offers an opportunity to address systemic institutional weaknesses and minimize the recurrence o f fiscal crisis.

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Recent policy actions undermine the reform framework and question govemment commitment. Institutional reform includes upstream budget formulation to downstream execution and accounting and audit (some o f which will no doubt depend on consensus at the national level).

208. Tamil Nadu, (and India) will need to find a politically viable solution to power sector reform to resolve the twin problems o f shortage and poor quality o f power supply, as a viable power sector i s critical for achieving fiscal stabilization, accelerating economic growth, and ensuring sustainability o f ground water resources which are depleting at an accelerated rate. Although power theft and corruption are a lesser issue in Tamil Nadu reducing cross subsidy i s critical to the financial viability o f the power sector. T o get the reform levers aligned so vested interests are not alienated and, most importantly, that poor people receive their rightful delivery o f social services, i s the challenge.

209. Equally challenging i s expenditure reform which reduces and/or redistributes benefits. First, user charges have to keep step to improve service delivery. Second, there i s limited scope for Tamil Nadu to increase i t s own tax revenues under the existing taxation powers conferred on states. Third, the increased infrastructure and social spending using newly created fiscal space (if fiscal reforms are successful) can only be gradual, and even in the long t e r m cannot be increased rapidly if economic growth i s not accelerated and if tax powers are limited. Fourth, i t will take time for infrastructure and social spending to translate into tangible benefits.

210. The reform program o f the government made a good beginning and i t s impact i s positive in the fiscal turnout upto 2003/04. However, recent policy choices o f reversing critical reforms already undertaken will impede expenditure restructuring efforts and jeopardize the gains made thus far. T h i s poses a threat to fiscal consolidation besides affecting the credibility o f the M T F P and fiscal and budgetary discipline. Particularly in the power sector, the government seems to have painted itself into a comer, and it i s hard to see how in the current environment any plan for financial recovery can be worked out. If, as seems likely given what has just happened, there are n o further tar i f f increases before the next state election, expected in 2006107, power sector losses could, in that year, exceed what it projected in the reformist business plan by as much as Rs 2,000 crore or more than 1% o f GSDP. In such a scenario, the consolidated deficit will be back at or above pre-reform levels, and productive spending wil l be crowded out by power subsidies. Tamil Nadu has n o choice but to retum to the path o f fiscal consolidation. Otherwise the success o f the reform program initiated by the Government looks uncertain with every possibility o f the state reverting to the fiscal distress highlighted in GoT"s 2001 W h i t e Paper.

21 1. Investment Climate: The reform agenda deals with not only regulatory policies and practices concerning a l l factor markets (labor, land, and capital), but also regulation o f entry/exit and tax pol icy and administration. Further, removing substantial infrastructure bottlenecks-power, road network, water supply, etc.-top the reform agenda. The wide scope o f issues i s not surprising, given that international competitiveness involves a l l critical chains o f investment, production and marketing. The agenda will thus require an institutionalized dialogue between the Government and the private sector for setting priorities and finding solutions. The private sector must be a sounding board and source o f information in formulating pol icy for the business environment.

212. Priority reforms comprise o f the following areas: labor market flexibility; a more responsive urban land supply system; a more efficient tax policy and administration; continuing reform o f entry and operation; power sector reform; and scaling up PPP for sustainable infrastructure development. M a n y o f the issues concerning investment climate are exclusively or largely within the purview o f the central government. This report confines itself to options for the reform agendas which are partially or main ly within the purview o f the state government. These are presented at Annex 3. I t must be recognized that there i s a balance between comprehensive reform and strategic selectivity. Therefore, the proposed agenda serves as a menu o f options f rom which a strategic yet programmatic reform agenda could b e

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formulated based on the Government’s own internal consultation, opportunities and constraints. Many o f the proposed reforms involve complex institutional reform that will take efforts beyond the medium term.

213. Agriculture. Traditional sources o f agricultural growth in Tamil Nadu face major constraints. Seasonal water shortages, increasing land degradation, continually shnlung farm sizes and rising costs o f agncultural labor represent serious constraints that need to,be overcome if future growth in agriculture i s to be realized. Given the existing constraints, diversification into less water-intensive higher-value products, including fruits, vegetables, spices, and livestock products, i s one o f the most promising avenues for increasing agncultural growth. Tamil Nadu’s agro-climatic conditions are well suited to diversified agnculture. Furthermore, rapidly increasing incomes and changing food demand patterns provide strong impetus for diversification. Increased agricultural diversification and private investments in processing for many o f the higher valued agncultural commodities are likely to generate new rural non- farm employment opportunities and contribute to higher rural incomes. Contract farming and other private sector initiatives should be encouraged, though the impact o f these business arrangements on farmer incomes should be evaluated, as well.

214. Overcoming the constraints faced by the agricultural sector in Tamil Nadu, and accelerating growth in agricultural production and the rate o f rural poverty reduction, wi l l require appropriate policies and investments in four priority areas: improving the efficiency o f water use; increasing the effectiveness o f public expenditures and agricultural extension; spurring the development o f agricultural markets; and maximizing the real income growth o f the rural poor.

215. More specifically, there are several options that Tamil Nadu could consider to manage i t s scarce water resources. These include: scaling up the pi lot river-basin framework for managing water resources holistically, allowing interagency coordination and public-private partnerships; introducing specific legally enforceable water entitlements to various users in a river basin and or aquifer framework; changes in electricity, water and crop prices to change the financial incentives for imgat ion and crop choice; improved management practices and irrigation technologies (such as drip and sprinkler irrigation) and new investments in canals and water storage (coupled with improved operation and maintenance).

216. Tamil Nadu i s the only state in India without a separate department o f irrigation: administration o f irrigation in the state i s part o f the Department o f Public Works. T w o new agencies are needed: a regulatory agency to allocate the share o f water resources to agnculture, industry and other uses, and an imgat ion department focusing on irrigation delivery systems.

217. Re-introduction o f agriculture power tar i f f (both flat rate on pump sets and metered) became a highly contentious issue in Tamil Nadu during national elections and were reversed. International experience with income support programs also provides several important lessons for providing clear incentives and containing fiscal costs, including the need for targeting to poorer farmers (e.g., paying more per hectare as farm size increases, with a ceiling o n the numbers o f hectares eligible for payment), an effective delivery system for the transfer payments, and a limit on the number o f years for which producers will be eligible for payments.

2 18. Gradual step towards marginal cost pr ic ing o f electricity, (perhaps combined with compensation to farmers in the form o f income transfers or a more reliable electricity supply), would help rationalize water use in Tamil Nadu. Metering o f farmers i s critical to link agricultural tariffs to consumption levels. Metering will also enable power subsidy to be better targeted. If farmers costs and incomes varied according to the amount o f electricity (and water) used with well irrigation, farmers would have an incentive to shift some land from water-intensive crops (rice and sugar cane) towards less water-intensive crops (including cotton, maize and vegetables). Greater attention to marketing infrastructure, strengthening the research and extension system to meet the needs o f diversified agriculture, the

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development o f tools for farmers to better manage risks, and improving irrigation pump set efficiency may create an environment within which higher power charges would be more palatable for farmers.

219. I t i s important to sequence the raising o f water and electricity tariffs as part o f broader package o f coherent policy and institutional reforms. These reforms are: decentralizing a traditionally top-down centralized extension system; facilitating efficient agncultural markets; developing a rural credit market, and developing an insurance and safety net program to cushion against the r i sk o f diversification particularly for small and marginal farmers who rely mainly on agriculture subsistence income; and a delivery package to improve farmer income associated with gradual adjustment o f input pricing.

220. Greater attention i s also need for scaling-up the adoption o f water saving irrigation technologies and modernizing irrigation infrastructure. Improving the productivity o f rainfed agriculture will require new investments and increased emphasis on community participation with sound technical inputs to improve the success o f watershed programs. A basin perspective should be adopted in implementation o f a l l watershed programs to ensure that these initiatives do not have negative impacts on downstream human and ecological uses.

221. Rationalizing public expenditures and shifting expenditures f rom subsidies to investments in key public goods such rural roads, markets and agricultural research and extension will facilitate productivity improvements and diversification o f agriculture to higher value products

222. Poverty Monitoring and Evaluation. There appears to be a case for paying special attention to the rural areas in the Coastal Nor th and the South, and possibly to the urban areas in the Coastal North. Scheduled Castes and Scheduled Tribes (SC/STs) also appear to face particular barriers to upward mobility, and the data suggest that these stem at least in part f rom three sources: access to land, education, and regular non-farm employment. Indeed these three barriers, although especially acute for SCISTs, tend to be characteristic o f the poor more broadly. Addressing them will therefore b e a vital part o f any poverty alleviation strategy pursued by the state. Given that the Tamil Nadu government has been laying increasing emphasis on assisting women, i t would n o doubt be useful to systematically identify the challenges facing poor women. Constraints o n employment and eamings appear to be an important deterrent to upward mobi l i ty amongst women, as wel l as other disadvantaged demographic groups, especially SC/STs.

223. Developing a comprehensive poverty reduction strategy will involve more investment in poverty monitoring. This i s obviously a grand undertaking, but the recent BPL survey i s an important step in this direction. It asks a number o f important questions regarding household characteristics, including income, asset ownership, and a few occupational and demographic characteristics. Since i t i s a census, the BPL i s amenable to the addition o f modules, which could be used to acquire data representative at least at the district level.

224. The G o T N expends considerable thought and effort in undertaking, the formulation o f goals and identification o f targets for i t s anti poverty programs. However, different programs are not always coordinated, with multiple, overlapping and sometimes conflicting objectives. Encouragingly, however, many schemes appear to be, or have the potential to be, broadly focused o n issues wh ich data suggest are important to the poor. More needs to be done regarding the design and implementation o f poverty alleviation schemes.

225. Monitoring and evaluation (M&E) requires strengthening. This i s not a problem particular to Tamil Nadu: i t i s common to al l o f the states in India, as it i s t o most o f the developing world. Monitoring o f extant anti-poverty policies and social services more generally is, however, important if one i s to gauge whether implementation i s proceeding according to plan and achieving i t s stated objectives. This i s a continuous process, instrumental in identifying problems to b e addressed. Impact

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evaluation involves isolating the effects o f a particular policy -- assessing i t s effect on welfare and living standards. The G o T N i s an ideal agent for engaging in M&E, given i t s voluble commitment to combating poverty, openness to receiving feedback, and r ich human capital resources. Impact evaluations are most appropriate to programs which are innovative, replicable, involve substantial resource allocations, and have well-defined interventions. I t i s also obviously the case that impact evaluations are best conducted on policies which are viewed as important to social welfare.

226. Service Delivery and Public Administration: The followiag measures are suggested for improving the efficiency o f Government administration: (a) Implementation o f the SERC recommendations across departments and the Secretariat over a three year time-period, resulting in the elimination o f surplus posts; (b) Introduction o f a computerized file-monitoring system to reduce delays in fi le movement, in conjunction with level-jumping, the single-file system, and greater delegation o f powers; (c) The Government has already issued a Government Order o n transfers covering the entire c iv i l service. The creation and implementation o f a public transfer database on the Internet to track transfers wi l l provide a basis for formulating additional measures to improve the transfer process including computerized counseling in health and education and adopting legislation to limit transfers; and (d) Creating a human resource database for c iv i l servants’ to facilitate better employee tracking, forecasting, and career planning.

227. Reducing Corruption: (a) Creation o f an independent institutional mechanism to focus o n corruption and grievance redressal in service delivery, and greater transparency in the functioning o f D V A C (e.g., tabling o f reports within three months o f their submission, creation o f a public website with data on complaint numberdtypes, pendency rates, and outcomes over time); (b) Adoption o f a new Tami l Nadu Right to Information (RTI) Act, with minimum exceptions, strong suo-motu disclosure provisions, and independent appeals process; and (c) Implementation o f further procurement reforms.

228. Strengthening Service Delivery: (a) Revision o f citizen charters’ for agencies with large public interface on a priority basis (e.g. district hospitals) and use o f surveys to provide feedback; (b) Continuation o f service delivery improvements in key agencies (e.g., Registration, Transport, Revenue, and Public Distribution System); and (c) Expansion o f E-Governance by promoting single-point delivery o f services, beginning with Chennai, and the spread o f rural information kiosks.

229. Electoral politics and capacity constraints may lead to reform uncertainty and polit ical sensit ivi ty to many reforms. What i s critical i s the political commitment to reform, as wel l as the sequencing and prioritization o f reforms, and careful managing o f trade-offs in reform gains, costs, and risks. T o do so, i t i s important to build a broadly-shared consensus through public debate and to carefully design a minimum set o f policies and programs to compensate for the impact o f reform, so as to maintain a critical mass o f support for reforms to proceed. GoTN’s capacity to manage a complex and growing reform agenda requires strengthening. Substantial capacity building and broad-based knowledge partnerships can help address the management o f reforms in priority areas such as water resources management, agriculture diversification, public expenditure management, and public-private partnerships in infrastructure financing and development.

59

60

Annex I. A Functional Reorganization Scheme for the Commercial Tax Department

Move to a functional structure. Moving from a territorial to a functional structure in the commercial tax administration i s probably the single most important reform initiative the Tamil Nadu government can take to reform tax administration. The reorganization would have to be carried out at the headquarters and territorial levels. It would create the necessary organizational basis for separating and strengthening the key tax administration functions o f registration, audit, collection, and taxpayer services. Figure A1 .1 outlines a typical functional tax administration structure.

Figure Al.1: Tax Administration Structure

I Commissioner Commerdal Taxes

J.C. J C . J K J.C. J,C. D.C. F.A a CA D.C. Registration Audit Collection Taxpayer Service Administration Legal Information

and Assessment and Technology Enforcement

In order to mitigate r isks and develop a clearer understanding o f the operation o f a functional tax administration, the reorganization could be implemented in stages and begin with a pi lot site. The establishment o f a new large taxpayer unit in the Commercial Tax Department would offer an ideal venue for such a pilot.

Create a special structure for large taxpayers: A small number o f large traders contribute the bulk o f sales tax collection in Tamil N a d ~ . * ~ T o address the compliance r i s k s and the special service needs o f this group o f taxpayers, the government should set up a special large taxpayer unit responsible for the administration o f the largest 200-500 traders in the country, and staffed with senior and experienced tax officials. Such a unit would also considerably facilitate the introduction o f a VAT. As discussed above, the unit should be organized along functional lines.

Streamline the territorial structure of tax administration: Fol lowing the successful piloting o f the functional structure in the large taxpayer unit, the reorganization needs at the territorial level should be addressed. The current 323 assessment circles should be abolished and tax administration tasks transferred to the 40 district offices. Circle offices would, however, be maintained and transformed into service posts where appropriate.

Strengthen the hunian resources of the Coniniercial Tax Department: A professional and specialized tax administration requires an appropriate level o f highly qualified staff. T h i s requires increasing the percentage o f senior staff at officer level in the administration.

23 Currently, the largest 400 taxpayers-representing 0.37% o f assessments-account for 75% o f total sales tax collections.

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Strengthen the enforcement fiutction: A total o f 4,646 inspections o f dealers were conducted in fiscal year 200 112002. These inspections resulted in the assessment o f additional taxes and penalties amounting to Rs.211.86 crore, which accounts for only 3% o f total sales tax collections. Enforcement productivity i s thus extremely low. T o enable the department to counteract tax evasion more effectively requires strengthening risk analysis for case selection; moving from a routine desk inspection to a targeted field inspection system; introducing an enforcement management system with clear plans and regular review o f performance o f enforcement units; and training o f professional staff.

Establish a vigilance unit: The Commercial Tax Department has an audit wing responsible for internal audit o f i t s operations. The audit wing focuses primarily on reviewing the correctness o f the assessment work, but does not assume responsibility for ensuring integnty and counteracting corruption in the tax administration. T o investigate taxpayer allegations against tax officials and detect corrupt practices and officials in the department, a special vigilance unit should be established.

The current commercial tax system has two unusual features that complicate contpliance by the business community: First, the current sales tax system i s not based on self-assessment. Temporary self-assessment i s possible only for a small group o f small taxpayers with a turnover o f less than Rs.10 crore and-in the case o f the sales t a x - o n l y if the taxpayer declares a 10% increase in the taxable turnover over the preceding year. Modem tax administrations, however, have moved to a universal self-assessment scheme for sales t a d V A T and have, when the scheme i s introduced in phases, started not with small taxpayers, but with the small group o f large taxpayers, for which self-assessment i s more feasible and important. A review o f the self- assessment approach chosen and the development o f a roadmap for moving to universal self- assessment will therefore be required. Second, efforts should be made to facilitate the registration process for sales taxpayers and, in future, for VAT taxpayers. The process i s comparatively long-almost one month-while many tax administrations manage to register taxpayers within 72 hours f rom the moment o f filing the application. The Government is, understandably, concerned about the risk o f registering non-existent or fly-by-night f i rms, and efforts to reduce these r isks are perfectly justified. Nevertheless options should be considered to make the registration process more taxpayer-friendly, without neglecting the need to mitigate risk. The options should also include reviewing the requirement to re-register businesses periodically and charging annual registration fees.

Tamil Nadu faces substantial problems in determining the taxable value of real property and enforcing payment of stamp duties for property transfers: Valuation for stamp tax purposes i s based on a guideline value,. which i s determined by a Value Fixation Committee. Guideline values are frequently subject to disputes and are not upheld in court. Taxable transactions are either not reported to the Registration Department, or the registration i s delayed. Frequent use o f fake stamps causes additional revenue losses, so that the actual tax revenues collected by the Registration Department are far below the revenue potential.

Problems in collecting stamp duties, especially on real estate transfers, cannot be addressed exclusively from a tax administration angle: They are part o f a broader problem o f keeping up- to-date records on property ownership and sales. A well-functioning cadastre system i s necessary for eliminating the possibility o f unrecorded property transfers. A revision o f cadastral records therefore needs to be launched. Tamil Nadu can benefit in this respect f rom the experience of some states that have embarked on this exercise already; in particular the experience o f Uttar Pradesh and Kamataka with using satellite technology for this purpose could be relevant. On the tax side, the interest and penalty system for delayed applications for registering property transfers needs to be reviewed. Efforts to set more reliable property values need to be pursued, in

62

particular by establishing a Central Valuation Committee, following the recommendation o f the Empowered Committee o f State Finance Ministers and the positive experience with the operation o f such committees in other states. Further computerization o f the valuation process, talung into account experience in Andhra Pradesh, and especially in Maharashtra, could facilitate property valuation. Valuation for stamp duty purposes and for assessment o f the urban land tax could be harmonized. The overall result o f the reform process should not only be an increase in stamp duty collections, but a quicker processing o f registration requests, which would support a more dynamic real estate market.

63

Annex 2: Budget and Financial Management Reforms

Budget and Policy Formulation

Strengthening pol icy formulation 0 Establish an apex Policy Reform Committee l inked to a network o f policy research

instituteshniversities to upgrade quality o f policy proposals. 0 Establish an annual forum with stakeholders to report on development progress and to invite

comments o n proposed policy initiatives.

Strengthening budget formulation As a priority, develop capacity to undertake multi-year revenue forecasting in Department o f Finance. Formalize the functioning o f a standing Expenditure Review Committee as part o f the annual process o f reviewing budget submissions to eliminate unproductive programs and improve efficiency o f existing programs. Ensure budget preparation process encompass expenditures due to al l “new policy, provision o f a new facility, or any substantial alteration in character or extent o f an existing facility.” Eliminate policies or schemes that violate established budgetary review and vetting process. Initiate time-bound implementation o f expenditure rationalization recommendations o f the Staff and Expenditure Reform Commission. Establish a w o r h n g group to (a) develop recommendations on rationalization and accessibility o f budget documentation and (b) update the budget manual. Initiate Zero-Base Review o f Schemes and programs; close those with doubtful benefits and merge others, which are similar in nature post review. Adjust budget schedule to ensure that the Appropriation A c t i s passed by the beginning o f the fiscal year.

Strengthening budget execution 0 Initiate and complete a full review o f budget execution procedures (cash management, release o f

cash or letters o f credit and payment, control processes, predictability and scope for departmental virement) to identify factors that contribute to under-spending, arrears, end-of-year spike in spending, etc. Implement recommendations f rom such review. Introduce quarterly circulars providing departments with information on anticipated cash disbursement‘letter o f credit limits for next quarter. Delegate greater financial powers to allow managers more discretion in managing inputs. Provide departments with greater authority over discrete blocks o f budget appropriation and increasing the unit o f parliamentary appropriation.

0

0

Improving fiscal accounting 0

0

Adopt a clear and internationally standard definition o f the fiscal deficit to be reported in the fiscal accounts. Initiate improvements to accounting system within the current system.

Prepare and publish regular reports o n fiscal and revenue deficit. Monitor and report payment obligations, arrears and guarantees issued.

o Discourage and limit transfer o f resources from consolidated fund o f the state to the public account. Improve timeliness and comprehensiveness o f reconciliation o f accounts across treasury, department and accountant general.

64

0 Develop and implement a medium term strategy for networked computerization o f financial transactions and records and adoption o f department-based financial management. Improve and strengthen the internal audit function. 0

Improving accountability to Legislature 0

0

Ensure more complete and prompt departmental responses to audit paragraphs. Avoid delays in obtaining ex post legislative authorization o f expenditure in excess o f appropriation.

Taxation Policy and Administration

Tamil Nadu’s own tax revenue effort i s amongst the highest in Indian states. Nonetheless, there i s considerable room for improving the efficiency, equity and administration o f the tax system to increase revenue yield and investment friendliness.

Tax policy

Continue preparation for the introduction o f the VAT; and prepare appropriate legal acts to l e v y tax o n goods and services that should cover taxes such as the Special Additional Sales Tax and some type o f presumptive taxation applicable to small dealers not covered by the VAT. Consider to switch State Excise f rom the current specific excise to ad valorem levied on the Maximum Retail Price o f alcoholic beverages. Streamline duties on dutiable instruments (especially financial instruments), moving some to ad valorem. M ino r duties may be either abolished or increased to justify the collection costs. Consider raising non-transport vehicle lifetime taxes to 8% in l ine with some other states. Revamp fees for permits, registration, licenses, f i tness certificates on motor vehicles, increasing revenue potential f rom road tolls, and raise the “green tax.” In addition, part o f the road user charges can always be incorporated into the fuel/diesel price through increased sales andor excise taxes. Abolish Entry Tax o n motor vehicles and goods upon introduction o f VAT.

Tax Administration

Short term 0

0

0

0

0

0

Prepare a five-year tax administration reform strategy. Streamline reporting and accountability arrangements for revenue collection. Establish a Central Valuation Committee for fixing guideline values. Establish a vigilance unit in the Commercial Tax Department (CTD). Issue a uni form taxpayer identification number and revise taxpayer registration process. Create a pi lot Large Taxpayer Unit (LTU) in the CTD, structured along functional lines.

Medium-term 0

0

0

0

Prepare an annual audit plan and training for auditors. Prepare a HR audit and training plan. Introduce self-assessment for large taxpayers. Start roll-out o f LTU concept.

65

Long-term 0

0

0

Full roll-out o f LTU concept: move to a functional tax administration organization. Abolish assessment circles and transform circle offices into service points where appropriate. Transfer responsibility for collecting other taxes to CTD.

Expendititre Reform

Pension reform

Year 1

Produce assessment o f transition costs o f moving from pay-as-you-go financing to funding. The government will have to pay ha l f o f the overall contribution as employer. This has fiscal implications that depend on the chosen contribution rate and, more importantly, on how many current c i v i l servants are allowed / encouraged to move to the new scheme. The ‘transition cost’ must be in l ine with fiscal realities. Determination and announcement o f parameters o f the new defined contribution scheme. A series o f parameters remain to be determined before the scheme can be started. K e y among these i s the contribution rate, the retirement age, the payout options and the treatment o f the GPF account. These may be influenced by GoI’s recent announcements in these areas. Determination and announcement o f ru les regarding the choice between the existing defined benefit (DB) scheme and the new defined contribution (DC) scheme for those already participating in the former. The conditions o f this option must be designed in line with fiscal plans. Implementation o f new information systems required to track individual accounts for members o f the defined contribution scheme o n a regular basis for government offices in Chennai.

Year 2 Dissemination o f information regarding the pension system options available to c iv i l servants. C iv i l servants faced with a choice as to whether to stay in the current DB scheme or move to the new D C scheme should be provided with adequate information. (This assumes that there i s a choice rather than a mandate). Implementation o f information system for tracking individual accounts in the defined contribution scheme to at least 90 percent o f eligible government employees Development o f plan to link new scheme to the infrastructure created under the Pension Fund Regulatory and Development Authority. Adopt revalued lifetime average earnings to plan for the target replacement rate when designing the provisions o f the defined contribution scheme. Index pensions automatically to price increases instead o f ad hoc wage indexation every 10 years through Pay Commissions.

Salary control

0 Continue staff rationalization as per the Staff Expenditure and Reform Commission’s

0

recommendations. Link wage indexation decisions to capacity to pay.

66

Subsidy reduction

0 Improve targeting o f the poor in the PDS by incorporating incomeiasset criteria and gradually raise public distribution system price o f rice to B P L issue price o f the govemment o f India. Evolve guidelines to manage growth in grants-in-aid o f salary expenditure to higher educational institutions and private aided schools. Audit subsidies and phase out subsidies o f doubtful benefit.

0

0

Improving capital outlay and non-wage O&M

0 Reallocate expenditure towards non-wage O&M expenditure in critical sectors and capital outlay. Leverage capital outlay to scale up public private partnerships. Progressively reduce budgetary support to Public Sector Enterprises and cooperatives through different means such as loans, grants, waivers, non-recovery and Ways & Means support.

0

0

Reform o f Public Sector Enterprises

State Transport Units

0

0

0 Improve staffhus ratio. 0

Continue containment o f salary and pension growth. Continue to reduce operational loss.

Implement phased program o f privatizing selected routes and services, subject to legal case in the court being ruled in favor o f the govemment.

Other public sector units and cooperatives

0

0

0

0

Formulate a time l ine for restructuring and divestment and transparent guidelines for divestment. Formulate a strategy and action plan for sales o f assets and divestment. Carry out environment audit for units to be closed / sold. Conduct training and counseling program for retrenched workers.

Power sector reform

0 Formulate and implement a comprehensive reform program addressing the need for sector restructuring for transition to a financially viable power sector -in accordance with the requirements o f India’s new Electricity Ac t 2003 (Act) as wel l as specific needs o f the state. Increase cost recovery from domestic power consumers.

Combine metered power supply to agriculture with a package deal to improve agricultural services delivery combined with marginal cost recovery level power tariff, efficient pump sets, less water intensive crops, and direct subsidy to the poor. Address high power purchase costs and introduction o f competition in the power sector. The open access provisions in the Act, if carefully implemented, can result in substantial private investments in generation with reasonable costs. Improved cost recovery f rom rural areas to be planned to balance increase in costs with improved service delivery, so as to prepare for the reduction in cross-subsidy.

0

0 Limit TNEB’s borrowing requirement. 0

0

0

0

67

Management o f Debt and Contingent Liabil it ies

0 Eliminate off-budget borrowings. 0

0

0

0

Continue debt swaps and seek extension o f swap scheme to other costly borrowings. Eliminate the existing system o f incentives for mobilizing small savings. Abide by the limit o n risk weighted guarantee limits under FRA. Establish a set o f formal ru les to govern eligibility o f PSUs, cooperatives and statutory boards for government guarantee. The rules could take into account financial statements, record o f profitability, performance on past guarantees, priorities o f government, etc.

68

Annex 3. Reforms to improve the Investment Cl imate

Labor marke t f lexibi l i ty

Within the constraint o f national legislation, the state government can explore ways to rationalize the legal framework governing labor and statutory compliance requirements to create elbow room for contractual labor relationship and for easing threshold for retrenchment. More specifically, the following can be considered.

1.

2.

3.

4.

5.

6.

1.

2.

3.

4.

1.

Short term Carry a complete review o f the entire spectrum o f Labor Laws governing Tamil Nadu and the machinery needed to implement these laws. Bring in flexibil i ty to Factory Ac t on working hours, overlapping o f shif ts work days, working on holidays either through State Amendments o f the Act or through exemption under section 65. Bring in State Amendments to the Contract Labor (Regulation and Abolition) Ac t 1970. Through the amendment, redefine what constitutes a "core" activity and reclassify many activities to the "non-core" l is t , allow hiring o f contract labor in activities, l ike sanitation works, security services, canteen and catering services, health services, courier services, gardening and maintenance services, transport services, and other activities o f intermittent nature even if they constitute core activities (e.g. hiring contract labor in production l ine to meet unexpected export orders). Furthermore, the decision should be l e f t with the f i r m s to decide what i s core and non core. Amend the notifications under the Shops and Establishment Ac t to remove inflexibility regarding working hours and also dismissal o f employees. Review licensing procedures in all the labor related laws to remove unnecessary procedures, simplify and ensure compliance. Remove inflexibilities introduced in the past by the state related to the Industrial Disputes Act. Initiate State Amendments to amend Chapter VB like Maharastra government and perhaps fol low the example o f the Andhra Pradesh government, which i s the process o f initiating amendment to Chapter VB to raise the number to 1000.

Medium term Amend Section 16 o f the Trade Union Act, 1926, which contemplates constitution o f a separate fund for polit ical purposes. Empower the Registrar o f Trade Unions to adjudicate upon a dispute as to which o f the office bearers are validly elected and limit the number o f unions in any establishment. Initiate State Amendments to the Industrial Disputes A c t 1947 and Shops and Establishment A c t to allow termination under reasonable grounds, differentiation between the termination o f temporary and permanent employee, introduction o f probation period and confirmation period, removal o f compulsory regularization o f a person who works for more than 2 years and to provide for court awarded compensation instead o f reinstatement and permitting compulsory retirement under the Industrial Disputes Act. The Presiding Officers o f the Labor Courts to be given Special Training or to have trained personnel for the resolution o f the disputes. Evaluate the need for Minimum Wages Ac t (1948) and the Rules 1950. Extend the exemption if necessary.

Longer term Consolidate the 27 Central and 7 State Laws into Industrial Relations and labor matters. L i ke most other developing countries, steps need to be taken to consolidate labor regulations to 5 main legislation to govern, f i r s t the relationship between employer and employee (Employment Act),

69

second to govern quasi judicial body that arbitrates between employer and employee (Industrial Disputes Act), third to govern the activities o f employees in unions (Trade Unions Act), fourth to govern welfare and compensation (Workman Compensation Act) and fifth to govern safety and security at work (Occupational Safety Act).

2. Carry out institutional reengineering to make the regulation o f labor effective and cost efficient. 3. Consider establishing an independent body l ike Labor Regulatory Authority to deal with

retrenchment and closure o f factories.

Urban land market reform

The focus should be on rationalizing regulations o n zoning and development controls, pro ject approval and l a n d acquisit ion processes, and developing a more effective planning and management system to facilitate infrastructure development.

1. Initiate a land market assessment in the Chennai metro area and select towns to identify an inventory o f publicly owned land.

2. Complete a through review o f real estate and land development regulations (regulatory audit). 3. Identify needed reforms. 4. Prepare report on the results o f the assessments. 5. H o l d series o f meetings with government and private sector stakeholders o n the results. 6. Fol low up support to assist government and private sector to implement reforms. 7. Monitor implementation o f reforms and assess and evaluate their effects.

Streamlining regulations o f entry and operation

1. Work with private sector representatives in the construction and real estate business to review problems in entry regulations.

2. Develop an action plan to ease entry regulations. 3. Identify clearance delays if any. 4. Complete the ongoing exercise reforms to consolidate 53 retums/registers into one common form. 5. Extend the simplified entry approval system for large investment projects (Rs.250 mi l l ion) t o

cover small and medium projects as well.

Scaling up private sector involvement in infrastructure service delivery

The government has announced plans to establish an Infrastructure Development Board and an infrastructure fund o f Rs.200 crore in the 2003 Industrial Policy. A Infrastructure Development Enabling legislation i s being prepared. All o f them a im to scale up public and private partnership in the development o f infrastructure. In going forward, key issues the government may consider are:

1. Reduce dependence on national and state budgets by promoting access o f Urban Local Bodies, utilities and govemment agencies to adequate and sustainable sources o f infrastructure finance.

2. Strengthen creditworthiness o f local bodies and state utilities for accessing private capital by providing selective credit enhancement where required to enable them to set a track record for future borrowings.

3. Develop financing mechanisms with targeted use o f state government contribution and guarantees and link municipal financing with domestic capital markets.

4. Choose and select projects which best fit state/local priorities for economic development and have sound economic value. /-

70

In order to mobilize financing in a robust PPP framework, the following essentials would need focus:

1. Develop an appropriate and comprehensive regulatory environment which establishes ru les o f the game for PPP and Private Sector participation; determining service ownership, developing legal framework for concessions, contract enforcement, bankruptcy and lender remedies.

2. Bring about financial discipline and enhance revenues through, depoliticising tariffshser charges, implementing overall cost recovery and creating dependable infrastructure revenue streams.

3. Link state transfers to performance benchmarlung for ULBs and utilities. 4. Build and enhance capacity in local bodies for project design and structuring, project evaluation,

contracting and implementation, financial planning, budgeting, and strategic planning.

71

MARCH

Rupees Billion in current prices

STATE GOVERNMENT

Rl"D""e State's Own Rwrnurr

Tar NOD- Tar

Shared Taxes Grants

Cem'aI Taxes

Non- lnterest Expenditures Salaries (incl GIA for ducation) Pmiions& RcdremtBencfiu

olw P m d m Non- Wage 0 & M O!hn Revenue Expmdirures Subsidies and Transfers

Food Subsidy Power Subsidy Hydcl SHhg Subsidy Others

TranEfns

Subsidies

oIw Compensation to Loeal bodies Capiul Outlay Net Lending

TN Primly Surplus (+)I deficit (-) Interest Pa)".!

Go TN Revenue Surplus (+YDeficil(-)

Go TN FIscd Surplus (+)/Deficit(-) I

Fiscal Data Annex 1.1 (a) : Fiscal Summary

1990191 1991192 1992193 1993194 1994195 1995196 199W97 1997198 1998199 1999100 2000101 2001102 2002103 2003104* 2004105 BE

50.4 60.3 68.8 34.6 41.1 46.4 31.2 37.3 416 3 4 3 8 4 s

15.8 19.2 22.4 L O O 119 142 5 8 7.3 8 2

56.8 68.1 79.8 235 257 288 3 5 4 4 5 6 3 5 4 4 4 8 9 2 I 0 8 115 0 0 0 0 0 0 148 213 270 5 8 10 I 13.3 2.6 3 6 6 8 1 8 4 3 3 6

1 4 2 1 2 5 9 0 112 138 I 1 2 0 2 9 2 3 3.6 4 0

3 5 2.2 2 8

-6.4 -7.7 -10.9 4 8 5 9 7 3

-5.4 -7.9 -113

-11.2 -13.7 -18.2

78.8 53.2 48 0 5.2

25.6 15 5 10 I

83.1 32 3 6 0 5 2 12 7 0 1

24 6 10.8 3 9 4 0

2 5 13 8 1 3 6 3

1 2

-4.3 10 0

-6.8

-143

90.5 64.3 58.3 6.0

26.1 17 4 8 8

93.9 36 2 6 4 5 5 14 1 0 1 25 6 12 8 5.2 5 1

2 3 12 8 1 3 4 8

6 7

-3.5 I 1 5

-3.5

-15.0

104.4 117.8 134.5 141.3 160.7 180.5 78.5 86.9 96.7 106.5 120.2 137.2 715 798 869 963 1092 1228 7 0 7 1 9 9 103 110 144

15.9 30.9 37.8 34.8 40.5 43.2 18 I 21 7 273 24 I 26.7 27 8 7 8 9 3 105 107 138 154

103.2 41 6 7 9 6 9 I S 0 0 1

29 2 I 5 2 8 0 3 5

126.4 48 3 10 8 9.0 17 3 0 2 36 4 17 9 100 3 8

140.3 55 6 12 9 I 1 0 18 I 0 2 41 3 17 5 100 3 6

169.1 74 7 170 14 7 19 4 0 1 39 7 I 5 0 5 0 3 3

192.1 82 4 27 5 26 8 18 2 0 1 40 5 14 4 7 1 2 5

205.4 82 5 29 5 26 I 18 7 0 1 49 2 23 0 154 0 9

3 1 3 2 3.4 5 6 4 0 5 1 1 4 0 18 5 23 8 24.7 26 1 26 I 2 1 3 1 7 9 1 0 2 102 9 7 5 9 9 4 121 163 2 0 1 246

3 5 4 2 0 0 1 9 3 4 0 9

1.2 -8.6 -5.8 -17.8 -31.6 -25.0 138 159 176 212 2 7 1 309

-3.2 .10.9 -11.3 -30.8 -35.2 -30.3

-11.6 -24.5 -23.4 -49.0 -58.7 -55.8

185.1 142.6 130 I 12 5 415 28 7 13 8

201.6 82 6 30 6 24 5 16 8 0 1 45 I 22 9 15.3 3 2

3 5 22 2 7 2 24 I

2 2

-16.5 35 I

-25.3

-51.6

204.6 158.1 143 4 14 8 46.3 30 5 15 9

233.1 79 8 33 4 26 0 21 4 0 2 75 I 38 6 124 22 1 0.0 2 8 36 5 15 6 20 5 2 6

-18.6 41.1

-46.5

-69.7

234.1 1775 1594 18 0 56.7 35 4 21 2

228.7 79 6 32 9 26 5 24 8 0 6 65 2 18 6 8 0 0 0 2 5 6 5

47 1 14 8 21 8

4 4

5.4 47 0

-15.4

-41.5

245.4 190.8 174 4 16 5 54.5 37 I 17.4

2623 94 8 46 0 34 3 28 7 0 1 56 8 17 5 7 8 0 0 1.3 7 3 39.3 14 3 33 3

2.5

-16.9 52.3

-33.4

-69.2

I Memo Ilrms POWER SECTOR Rcvmue (Excl Power Subsidy) (I) 145 168 212 26.3 3 5 1 413 4 4 9 531 5 6 8 648 758 822 946 1161 1230 Cash Operaring Expmdirurc (excl Depreciation) (2) 154 150 196 250 299 360 4 0 0 4 7 6 5 4 9 676 766 943 I 0 0 0 1097 I 1 2 5 EamingbcfareInt,Dcpm,Tax&AppropmiEBIDTAli3)=i11-(21 - 0 9 1 8 I 6 1.4 5 1 5 3 4 9 5 5 2 0 - 2 9 -09 -121 - 5 4 6 3 105 I"tereSt(4) 2 3 1.7 2 7 3 0 3 4 3 8 4 2 4 7 4 9 5 8 6 4 6 5 7 2 8 0 8 9

NCI LmsIRofit i c x c l Depml bcforc Subsidy [.I+) (6) - 3 2 0 1 - 1 1 - 1 6 1 7 1 5 0 6 0 9 -29 - 8 7 -7.3 -185 -125 -17 I 6 Capital Outlay (7) 6 2 6 6 3 7 113 9.9 1 2 2 103 9 4 114 120 167 I 1 3 139 148 160 Ovnall Financing R e q u a c m t before Subsidy (+I-) I 8 1 9 4 6 4 4 9 129 8 2 10.7 9.7 8 5 143 207 2 4 0 298 264 165 144

Tlaxation (5) 0 0 0 0 0 0 0 0 0.0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

CONSOLIDATED ACCOUNTS

RWlIlYll Total Expenditures

Revmue Expmdirure Capital Outlay and Net Lending

Consolidated Revenue Surplus (+) I Defieit e) Connollditod Surplus (+)I Deficit (.) ( 9 F (1H8)1(11) Gross Borrowing Requirrmnt GoTN Fiscal Deficit (10)

Pawn Subsidy Capital Outlay & Net Lmding

d w Gross Budgetary Support to Power (11)

Noo-Po\*erDeficit~(12)=(10)+(11) Debt StOekofGoTN Gunr~nters GoTN Debt and Guanntecs I

64.8 81.4 71 7 9 7 -6.8 -16.5 -18.7 -11.2 4 1 1 8 2 4 -7.1 573 16.2 835

76.3 90.8 79 8 I 1 0 -3.5 -14.5 -16.9 -13.7 5 6 4 3 1.3

-8.1 67.8 29.3 97.1

89.3 1075 98 I 9 4 -8.8 -18.2 -21.1 -18.2 4 8 3 6 1 2

-133 80.0 17.4 97.3

104.4 126.1 108 9 174 -4.4 -21.8 -24.9 -143 5 4 4 0 1 4 -8.9 95.1 34.0 119.0

124.4 138.4 121 0 17 3 3.4

-14.0 -16.6 -15.0 9 2 5 1 4.1 -5.8

114.1 39.3

153.4

144.3 161.4 142 4 20.0 1.8

-18.2 -21.0 -12.6 5 2 3 5 1 6 -7.4

128.5 48.0 176.4

161.2 189.7 167 7 22 0 -6.4 -28.5 -32.0 -24.5 5 7 3.8 1 9

-18.8 145.5 50.2 195.7

185.9 208.5 192 8 15 7 -6.8 -22.5 -26.8 -23.4 9 3 3 6 5 7

-14.1 168.4 53.3 221.6

196.4 257.6 226 8 30 8 -30.4 -61.2 -66.9 -49.0 2 1 3 3 -1 2 -46.9 104.8 51.6

256.4

223.5 308.3 264 8 43 5 -41.4 -84.9 -91.5 -58.7 -5 5 2 5 -8 0

-64.2 259.7 72.1

331.9

253.9 335.8 290 6 45 2 -36.7 -81.9 -89.8 -55.8 -2 1 0 9 -3 0

-57.9 313.3 96.2

409.6

264.5 342.5 305 I 37 3 -40.6 -77.9 -89.4 -51.6 3 5 3 2 0 3

-48.1 356.7 87.9

444.6

297.8 372.3 334 8 37 6 -36.9 -74.5 -97.9 -69.7 21 6 22 I -0.5 -48.0 433.0 91.9

524.9

347.9 4013 365.0 37 3 -17.1 -54.0 -90.2 -41.5 3.6 0 0 3 6

-37.9 4745 108.1 582.7

366.1 449.9 398 0 51 9 -31.8 -83.7 -115.1 -69.2 -0 1 0 0 -0 I -693 5553 90.0

64S3

Power Sector Numbers for 2003104 arc forsasu tom the businerr plan In 2003104 the acual consolidated fiscal and rcvmuc dcficit arc higher by Rs 10 bn according to tbc Gavemmcnt Since details are not available this have no1 bem incolparatd in this table Tne aemal consolidated fiscal deficit in 2003104 i s 3 8% o f GSDP

72

I

1.1 (b): Fiscal Summary(%) GSDP) M A R C H

(As a Percent of GSDP)

STATE GOWRNMENI

RlVD""D State's Own Revenue

Tax Non- Tax

Centra1 T*XW Shared Taxes Grants

Non- Interest Expenditures Saiarier (incl GIA for education) Pensions & Retirement BeneficI

o/w Pensions Nan- Wage 0 k M Ober Revenue Expenditures Subsidies and Transfers

Food Subsidy Power Subsidy Hydci Swng Subsidy Others

Transfers

Subsidies

o/w Compensation IO Local bodies Capital Outlay Net Lending

I N P~imzry Surplus (+Y deficit (-) lnteres! PPymenU

Go I N Rwenue Surplus (tprfiUt(-)

Go I N Fiscal Surplus (+Wefirit(-)

GSDP

Memo Ilems POWER SECTOR Revenue (Excl Power Subsidy)(l>

1990191 1991192 1992193 199394 1994/95 1995196 1996197 1997D8 1998199 1999100 2OWlOl 2001102 2002103 2003104' 2004105 BE

16.1% 163% 16.0% 13.7% 13.2% 13.3% 13.2% 13.0% 11.9% 12.7% 12.8% 125% 133% 13.1% 13.7% 11.0% 11.1% 10.8% 9.3% 9.4% 10.0% 9.7% 9.3% 9.0% 9.5% 9.7% 9.6% 103% 10.4% 10.6% 100% l O i % 9 7 % 8 4 % 85% 91% 85% 84% 81% 86% 87% 8 8 % 93% 9 4 % 97% 11% 10% 11% 05% 09% 09% 08% 10% 0 9 % 05% 1 0 % 0 8 % 10% 11% 0 9 % 5.0% 5.2% 5.2% 4.5% 3.8% 3 3 % 3 5 % 3.6% 2.9% 3.2% 3.1% 2.9% 3.0% 3.3% 3.0% 3 2 % 3 2 % 3 3 % 2 7 % 2.5% 2 3 % 2 4 % 2 6 % 20% 2 1% 20% 1 9 6 2 0 % 2 1% 2 I% 18% 2 0 % 15% 18% 13% 10% 10% 10% 0 9 % I I% 11% 0 9 % 10% 12% 10%

18.1% 7 5% 11% 11% 2 5% 0 0% 4 7% 1 8% 0 8% 0 6% 0 0% 0 4% 2 9% 0 3% 0 7% 1 1 %

18.4% 7 0% 1 2% I 2% 2 9% 0 0% 5 E% 2 7% 10% 11% 0 0% 0 6% 3 0% 0 5% 1 0 % 0 6%

185% 6 7% 1 3 % 11% 2 7% 0 0% 6 3% 3 1% 1 6% 0 8% 0 0% 0 6% 3 2% 0 7% 0 9%

0 7%

14.5% 5 6% 10% 0 9% 2 2% 0 0% 4 3% 1 5% 0 7% 0 7% 0 0% 0 4% 2 4% 0 2% 1 1%

0 2%

13.7% 5 3% 0 9% 0 E% 2 1% 0 0% 3 7% 1 5% 0 7% 0 7% 0 0% 0.3% I 9% 0 2% 0 7% 10%

13.2% 5 3% I 0% 0 9% I 9% 0 0% 3 7% 1 9 % 1 0 % 0 5% 0 0% 0 4% I 8% 0 3% 0 8% 0 5%

14.1% 5 4% 12% I 0% 1 9% 0 0% 4 1% 2 0% 11% 0 4% 0 0% 0.4% 2 1% 0.3% 1 0%

0 5%

135% 5 4% 12% 11%

0 0% 4 0% 1 7 % 1 0% 0 3% 0 0% 0 3% 2 3% 0 8% I 2% 0 0%

I 8%

14.3% 6 3% 1 4% 12% I 6% 0 0% 3 4% 1 3% 0 4% 0 3% 0 0% 0 5% 2 1% 0 9% 1 4% 0 2%

15.2% 6 5% 2 2% 2 I% 1 4% 0 0% 3 2% I I% 0 6% 0 2% 0 0% 0 3% 2 1% 0 E% 16% 0 3%

14.6% 5 E% 2 1% 1 5% 1 3 % 0 0% 3 5% 1 6% I I% 0 1% 0 09% 0 4% 1 9% 0 7% 1 7% 0 1%

13.6% 5 6% 2 1% i 6% i 1% 0 0% 3 0% 1 5 % I 0% 0 2% 0 0% 0 2% 1 5 % 0 5% 1 6 %

0 1%

15.2% 5 2% 2 2% 17% 1 4 % 0 0% 4 9% 2 5% 0 8"% 1 4 % 0 0% 0 2% 2 4 % 10% 1.3% 0 2%

13.4% 4 7% i 5% 1 6% 1 5 % 0 0% 3 E% 11% 0 5% 0 0% 0 1% 0 4% 2 8% 0 9% 1 3%

0 3%

14.6% 5 3% 2 6% 19% 1 6% 0 0% 3 2% I 0% 0 4% 0 0% 0 1% 0 4% 2 2% 0 8% I 9% 0 1%

-2.0% -2.1% -2.5% -0.7% -05% 0.2% -1.0% -0.6% -2.3% 4.5% -1.8% -1.1% -1.9% 0.3% -0.9% 1 5 % 16% 1 7 % 17% 17% 18% 18% 17% 18% 2 I% 2 2 % 2 4 % 2 7 % 2 8 % 29%

-1.7% -2.1% -2.6% -1.2% -0.5% -0.4% -1.2% -1.1% -2.6% -2.8% -2.1% -1.7% -3.0% -0.9% -1.9%

-3.6% -3.7% -4.2% -2.5% -2.2% -1.6% -2.7% -2.3% -4.1% -4.6% -4.0% -3.5% 4.5% -2.4% -3.9%

313.4 369.6 430.1 574.8 6875 184.9 894.9 10355 1182.8 1265.0 1411.5 1485.9 1537.3 17053 1793.1

46% 45% 4.9% 46% 5 1% 5 3 % 5 0 % 5 I% 4 8 % 5 1% 5 4 % 5 5 % 6 2 % 6 8 % 6 9 % Cash Operating Expenditure (excl Dqreciatlon) (2) 4 9% 4 0% 4 6% 4.3% 4 4% 4 6% 4 5% 4 6% 4 6% 5 3% 5 4% 6 3% 6.5% 6 4% 6 3 % Eaming before l n ~ Dqm, Tax & Appropm (EBIDTA) (1)-(2) -0 3% 0 5% 0 4% 0 2% 0 7% 0 7% 0 5% 0 5% 0 2% -0 2% -0 1% -0 8% -0 3% 0 4% 0 6% inrerest (4) 07% 0 5 % 06% 0 5 % 0 5 % 0 5 % 0 5 % 0 4 % 0 4 % 0 5 % 0 5 % 0 4 % 0 5 % 0 5 % 0 5 %

Net LowQrofit (excl Depm) before Subsidy (4+) (6) .I W% 00% -0 3% -0 3% 0 3% 0 2% 0 1% 0 1% -0 2% -0 7% -0 5% .I 2% -0 E% -0 1% 0.1% Capiul Outlay (7) 20% 18% 05% 20% 14% 16% 1 2 % 09% 10% 0 9 % 1 2 % 0 8 % 09% 0 9 % 0 9 % Overall Financing Requirement before Subsidy (+/-) (8) 3 0% 1.7% 11% 23% 12% 14% 11% 08% 12% 1 6 % 17% 205% 1 7 % 10% 0 8 %

CONSOLDATED ACCOUNTS

Taxalion (5) 00% 000% 00% 00% 00% 00% 0 0 % 00% 0 0 % 0 0 % 00% 00% 0 0 % 009% 0 0 %

RlW""l3

Total Expenditure Revenue Expenditure Capital Outlay m d Net Lending

Consolidate Revenue Surplus (+) IDefiUt (-) Consolidsled Surplus (+Y Deficit (.) (9); ( l b ( 8 M I l ) Grass Borrowing Requirement GoTN FiralDefieit (IO)

P o w a Subsidy Capital Outlay & Net Lending

d w Grar Budgetary Support to Power (11)

Non-PowrrDifidtr(I2)=(10)+(11) Debt Stock of GaTN Guarantees G I N Debt and Guarantee

20.7% 26.0% 22 9% 3 1% -2.2% -5.3% -6.0% -3.6% I 3% 0 6% 0 7%

-2.3% 18.3% 8.4% 16.6%

20.6% 24.6% 21 6% 3 0%

-0.9% -3.9% -4.6% -3.7% 1 5 % I I% 0 4%

-2.2% 18.4% 7.9% 263%

203% 25.0% 22 E% 2 2% -1.0% 4.1% -4.9% 4.2% 11% 0 8% 0.3%

-3.1% 18.6% 4.0% 22.6%

18.2% 22.0% 18 9% 3 0% -0.8% -3.8% -4.3% -2.5% 0 5% 0 7% 0 3% -1.5% 16.5% 5.9% 22.4%

18.1% 20.1% 17 6% 2 5% 0 5 % -2.0% -2.4% -2.2% I 3% 0 7% 0 6% -0.8% 16.6% 5.7% 22.3%

18.4% 10.7% 18 1% 2.5% 0.2% -23% -2.7% -1.6% 0 7% 0 5% 0 2% -0.9% 16.4% 6.1% 22.5%

18.0% 21.2% 18 7% 2 5% -0.1% -3.2% -3.6% -2.7'% 0 6% 0 4% 0 2%

-2.1% 16.3% 5.6% 21.9%

18.0% 20.1% 18 6% 1 5 %

-0.7% -2.2% -2.6% -2.3% 0 9% 0 3% 0.6% -1.4% 1 6 3 % 5.1% 21.4%

16.6% 11.8% 19 2% 2 6% -2.6% -5.2% -5.7% 4.1% 0 2% 0 3Y" -0 1% -4.0% 17.3% 4.4% 21.7%

17.1% 14.4% 20 9% 3 4% -3.3% -6.7% -7.2% 4.6% -0.4% 0 2% -0 6% -5.1% 20.5% 5.7% 26.2%

18.0% 23.8% 20 6% 3 2% -2.6% -5.8% -6.4% -4.0% -0 I% 0 I% -0 2%, 4.1% 22.2% 6.8%

29.0%

17.8% 23.1% 20 5% 2.5% -2.7% -5.2% -6.0% -3.5% 0 2% 0 2% 0 0% -3.2% 24.0% 5.9% 29.9%

19.4% 24.2% 21 E% 2 4% -1.4% 4.8% -6.4% 4.5% 1 4% 1 4 % 0 0% -3.1% 28.2% 6.0%

34.1%

20.4% 23.6% 21 4% 2 2% -1.0% -3.2% -5.3% -2.4% 0 2% 0 0% 0 2% -1.2% 278% 6.3%

34.2%

20.4% 25.1% 22 2% 2 9% -1.8% -4.7% -6.4% -3.9% 0 0% 0 0% 0 0% -3.9% 31.0% 5.0%

36.0%

73

1.2(a): First Xledium Term Fiscal Policy

MARCH

Rupees Billion in current prices

STATE GOVERNMENT

Revenue State's Own Revenues

Tax Non- Tax

Shared Taxes Grants

Central Taxes

Xon- Interest Expenditures Salaries (incl GIA for education) Pensions & Retirement Benefits Non- Wage 0 & M Other Revenue Expenditures Subsidies and Transfers

Food Subsidy Power Subsidy Hydei Swing Subsidy Others

Transfers

Capital Outlay Net Lending

T" Primary Surplus (+)I deficit (4

Subsidies

oiw Compensation to Local bodies

Interest Payments

Go TN Revenue Surplus (+peficit(-)

Go TN Fiscal Surplus (+)/Deficit(-)

Memo Items POWER SECTOR Revenue (Excl. Power Subsidy) (I) Cash Operating Expenditure (exci. Depreciation) (2) Earning before Int, Depm, Tax & Appropm (EBIDTA) (3)= (1)-(2) Interest (4) Taxation (5) Net LossProfit (excl. Deprn) before Subsidy (-I+) (6) Capital Outlay (7) Overall Financing Requirement before Subsidy (+I-) (8)

2002103 Accounts

204.6 158.2 143.4 14.8 46.3 30.5 15.9

233.1 79.8 33.4 21.4 0.2 75.1 38.6 12.4 22.1 0.0 2.8

36.5 15.6 20.5 2.6

-28.6 41.1

-46.5

-69.1

94.6 100.0 -5.4 7.2 0.0

-12.5 13.9 26.4

2003104* Accounts

234.1 117.5 159.4 18.0 56.7 35.4 21.2

228.1 79.6 32.9 24.8 0.6 65.2 18.6 8.0 0.0 2.5 6.5

47.1 14.8 21.8 4.4

5.4 47.0

-15.4

-41.5

116.1 109.7 6.3 8.0 0.0 -1.7 14.8 16.5

PROJECTIONS 2004105 2005106 2006107 2007108 2008109 <..-. _ _ _ _ _ _ _ _ _ _ ___ .._____.___.. ~ >

240.4 185.9 171.6 14.3 54.5 37.1 17.4

255.3 91.5 45.2 27.4 0.3 57.3 15.9 7.7 0.0 1.3 7.0

41.4 17.2 29.5 4.2

-14.9 52.7

-33.9

-67.6

123.0 112.5 10.5 8.9 0.0 1.6 16.0 14.4

266.1 202.8 187.9 14.9 63.3 44.1 19.2

212.5 96.1 52.1 29.1 0.3 59.4 15.3 7.4 0.0 1.3 6.7

44.1 18.0 32.8 2.7

-6.4 58.0

-29.0

-64.4

137.3 124.5 12.8 9.2 0.0 3.6 15.3 11.7

291.0 222.3 206.1 16.2 68.7 47.6 21.1

285.2 100.6 53.3 31.0 0.3 57.2 14.7 7.1 0.0 1.3 6.4

42.5 19.0 39.0 3.8

5.8 64.3

-15.7

-58.5

151.8 138.1 13.8 9.2 0.0 4.6 12.3 7.6

CONSOLLDATED ACCOUNTS Revenues 291.8 347.9 361.2 401.0 440.3 Total Expenditures 312.3 402.3 440.6 414.6 504.0

Revenue Expenditure 334.8 365.0 393.5 426.4 451.4 Capital Outlay and Net Lending 37.6 37.3 47.1 48.2 52.6

Consolidate Revenue Surplus (+)I Deficit (-) -36.9 -17.1 -32.4 -25.4 -11.1 Consolidated Surplus (+)I Deficit (-) (9)= (1)-(8)+(11) -74.5 -54.0 -79.4 -13.5 -63.1 Gross Borrowing Requirement -91.9 -90.2 -124.9 -93.2 -81.0 GoTN FiscalDeficit (10) -69.1 -41.5 -61.6 -64.4 -58.5

oiw Gross Budgetary Support to Power (11) 21.6 3.6 2.7 2.6 2.5 Power Subsidy 22.1 0.0 0.0 0.0 0.0 Capital Outlay &Net Lending -0.5 3.6 2.7 2.6 2.5

Non -Power Deficits (12) = (10) + (11) -48.0 -31.9 -65.0 -61.9 -56.0

318.9 244.3 227.3 17.0 14.6 51.4 23.2

306.5 104.9 58.6 33.7 0.3 59.1 14.2 6.8 0.0 1.3 6.1

44.9 20.7 46.5

3.3

12.5 70.7

-8.5

-58.2

179.0 154.0 25.0 9.0 0.0 16.0 18.0 2.0

349.4 268.4 250.8 17.6 81.1 55.5 25.5

326.3 110.3 62.9 37.1 0.6 61.3 14.2 6.8 0.0 1.3 6.1

47.1 22.6 50.5 3.5

23.1 76.7

0.4

-53.6

197.0 170.8 26.1 8.8 0.0 17.3 18.0 0.7

495.3 543.6 553.2 596.6 487.8 525.8 65.4 70.8 1.5 11.1

-57.9 -53.0 -18.7 -75.1 -58.2 -53.6 2.4 1.3 0.0 0.0 2.4 1.3

-55.9 -52.3

Debt Stock of GoTN Guarantees GoTN Debt and Guarantees

433.0 474.5 542.3 595.2 648.9 707.1 160.1 91.9 108.2 94.2 99.2 104.2 109.2 114.2 524.9 582.1 636.5 694.4 753.1 816.3 874.9

* Power Sector Numbers for 2003104 are forecasts from the business plan In 2003104 the actual consolidated fiscal and revenue deficit are higher by Rs. 10 bn according to the Govemment. Since details are not available this have not been incorporated in this table. The actual consolidated fiscal deficit in 2003104 i s 3.8% ofGSDP.

74